Corporate TreasuryFinancial Supply ChainSupply Chain FinanceVertical Awareness and the Financial Supply Chain

Vertical Awareness and the Financial Supply Chain

The days of the great western industrialists owning all physical aspects of their business models are behind us. The modern company is swift, lean and focused on efficiency. This change in approach created the ubiquitous practice of outsourcing and its new and different financial considerations, rules and challenges. Many companies are now only just realising, however, that to rely heavily on external partners does not mean simply signing a contract and turning one’s back. Rather, while companies might have given up on the idea of vertical ownership and control, they have yet to realise the importance of ‘vertical awareness’.

Vertical awareness can be described simply as being cognizant of how one action will create a reaction somewhere along the supply chain, and having the ability to positively influence the end-to-end physical and financial performance of the supply chain. Such actions can be physical or financial.

Supply Chain Management

What are we seeing in terms of financial supply chain focus? There are two main areas of focus driving effective financial supply chain management. First is leveraging technology to provide accurate information and event management along the supply chain – a discipline that has been evolving for a number of years now. The second driver is the ability to positively influence the end-to-end financial performance of the supply chain. Competitive leaders have realised that solitary financial solutions can never provide the same clarity and influence gained by partnering with a reputable global financial leader that can understand, analyse and positively impact financial cost.

Figure 1 provides a simple schematic diagram of an international supply chain, identifying the various areas of financial consideration. Companies that have clearly identified the importance of managing their end-to-end supply chains without actually owning them have done so by internally elevating the importance of having a supply chain organisation that breaks through traditional business unit silos to take into consideration the eventual impact of any and all actions.

Figure 1: Financing the Supply Chain

Companies that manage effective supply chains are more focused on collaborating with their partners, ensuring that no action creates a negative physical or financial reaction down the chain.

Balancing Working Capital Vertically

Commonly overlooked in evaluating outsourcing is the investment every company makes in its working capital. Historically, while companies have analysed their own working capital investment, they have ignored the working capital in the end-to-end supply chain not under their direct control. Only recently have businesses truly begun to explore and manage the upstream effects and impact on their performance from a downstream supply chain partner’s working capital structure.

Our above definition of vertical awareness tells us that managing a single financial dynamic of the supply chain never results in a solitary effect but rather the impact is realised across the whole supply chain. Traditionally, both the buyer and supplier have viewed their working capital management objectives as mutually exclusive. Managing down the uses of cash – inventory and trade accounts receivables – are common goals, as is managing up cost-efficient sources of cash, such as trade accounts payables. However, there is a link between the two: the buyer’s desire to reduce its use of cash via reducing balance sheet inventory can frequently push the inventory back onto the supplier.

Leveraging the trade payables as an effective source of cash now becomes an increased use of cash for the supplier. Conversely, an attempt to accelerate collection of accounts receivables by a supplier can adversely impact a buyer’s source of cash. Today, businesses are finding that in order to have an effective financial supply chain, and to be vertically aware of the impact finance has on the supply chain, they need to partner with both fiscally responsible suppliers and reputable financial institutions that are dominant in key trading markets. While ownership of the supply chain’s financial structure is neither desired nor necessary, being aware of and having clear access to the appropriate financial resources across the supply chain are both imperative and fundamental to business success.

Impact of Not Being Vertically Aware

Today, when companies do not take a vertical approach to their supply chains, we can identify seven major factors and questions that may arise:

  • Unclear knowledge of actual versus estimated cost of product.
  • Suppliers are unwilling and/or unprepared to accept additional expense and push it back into the unit cost.
  • What happens to key suppliers that are experiencing additional expense that the buyer is unaware of and, hence, cannot afford?
  • Does the supplier have the ability to retain adequate financial support from its bankers, and if not, what happens?
  • How dependent is the supplier on the buyer, and vice versa? Is there risk concentration?
  • What shortcuts will be taken to continue to supply product? What is the impact on product quality?
  • How does the buyer exert control and influence over its operating and profit margins, as expected by shareholders?

Companies that are not vertically aware of the potential impact across their supply chains when modifying their cash conversion cycles may be unaware that the results of such actions can be more damaging than not changing trading terms.

Conclusion

Companies that are focused on effectively managing their supply chain are more than ever looking to ‘sponsor’ the financial aspects of their supply chains. This does not mean that they are taking ownership of the financial responsibilities of their trading partners, but that they are clearly acknowledging the importance they play on many fronts. Today, more and more companies take an unprecedented approach to assisting their supply chain partners with gaining access to alternate sources of liquidity and ensuring that their key partners are as focused and disciplined as they are. Best-in-class companies blend this with ensuring that quality and delivery of product never suffers.

The approach to financial supply chain management discussed above is evolving. There is no perfect solution or model, as many challenges still exist in the financial supply chain, namely:

  • Resistance and fear of change among supply chain participants.
  • Being able to truly understand and influence financial cost at all levels of the supply chain.
  • Lack of relationship with the right global financial partner.
  • Credit markets can tighten quickly and impact the unprepared and unaware even more quickly than they can adapt.
  • Political, environmental and legal risks are frequently uncertain and need to be managed.

Companies must be aware of such risks and the far-reaching impact they can have. Partnering with the right financial institution that can lever itself along a supply chain is more critical today than ever before.

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