Large corporations are holding onto their cash, while small and medium-sized businesses (SMBs) are struggling to get affordable access to the liquidity they need for day-to-day operations and growth. This mismatch can be a drain on the entire economy. But there is an opportunity financial professionals can take advantage of that is right in their supply chain.
The future of managing cash promises to look very different from what today’s treasurers consider business as usual. Today, there are myriad fintech innovations designed to complement and support current financial tools.
Leveraging your supply chain as a working capital strategy
Today it’s considered best practice for companies to have programs in place designed to strategically leverage the supply chain for cash management and gross margin improvement purposes. These programs often take the form of extended payment terms paired with fixed cash discounts for early payment.
There is a considerable amount of work required to standardize programs and develop processes for the larger organization to support. Here are some recommendations to consider when developing a supply chain working capital strategy:
- Standardize terms and discounting: If terms and discounts are applied separately over time and vary widely among the eligible suppliers, it can be a challenge to manage them.
- Provide working capital optionality: Programs should not be limited to the largest suppliers. Consider options that include SMBs who need early payment the most.
- Examine cost of goods tradeoffs: Fixed early payment discounts have a tendency to incentivize suppliers to build the discounts back into the cost of goods over time, eroding improvements to the buyer’s gross margin.
- Keep programs simple to increase adoption rates: Complicated legal agreements for the buyer and supplier can increase the cost of implementing and decrease adoption rates from suppliers.
Many companies offer supply chain finance (SCF) for larger suppliers and have procurement card (P-Card) programs in place for smaller suppliers with smaller transactions. This leaves out a large group of suppliers in the middle.
A true dynamic discounting marketplace can fill in the substantial gap between large and small suppliers, benefiting your entire operation through improved margins and increased earnings before interest, tax, depreciation and amortization (EBITDA). It will also strengthen your supply chain by providing working capital to your suppliers when they need it at rates they find desirable.
The true dynamic discounting marketplace model
Many large corporations including Costco, Toys R Us, Pfizer and Mohawk Industries, have realized significant value setting aside strategic cash to make it available as working capital to their suppliers in return for a small discount on approved invoices. A successful program needs to maximize supplier participation, both in the number of suppliers using the program, how frequently they use it, and how well it serves the needs of suppliers big and small.
The ideal solution creates an environment that is fair and sustainable to both the supplier and buyer. A true dynamic discounting marketplace provides suppliers with an opportunity to submit early payment offers as needed to accelerate payment of invoices sooner than the negotiated terms would usually allow. Because the supplier chooses its desired rate for early payment and the frequency of usage, it reduces the risk of constant discounting being priced back into your cost of goods.
Buyers will appreciate a true dynamic discounting marketplace as well, as they control the desired rate of return for paying suppliers early. They will see an increase in cash discounts throughout the year and not just a one-time cash flow benefit due to terms standardization.
Perhaps the best thing about a true dynamic discounting program is that it offers risk-free returns because the company is investing in its own business. The corporate controls the amount of cash it makes available and the desired rate of return, and only approved invoices are eligible for the program. The benefits include cost reduction and improved gross margins and EBITDA. Buyers are also able to strengthen the supply chain by ensuring that suppliers have access to funding at rates that are better or at least competitive with alternative options (assuming they have access to funding at all). This approach will free up the supplier’s working capital so it can focus on improving the trade relationship with customers.
Sean Van Gundy is managing director, working capital advisory at C2FO.