Taxes, working-capital concerns bring purchasing and finance closer together
Like the phoenix rising from the ashes, financial supply chain management is taking on new life as the economy cools. And as it does, procurement and finance are working closer together.
By Paul E. Teague -- Purchasing, 1/15/2009 2:00:00 AM
The following story is true. We are withholding the names of the buyer and supplier to avoid embarrassing them.
A capital-equipment manufacturer that was diligent about auditing suppliers on a number of criteria found a weak link in the supply base. The weak link was a sole-source supplier of a critical component. Normally, such a discovery would be hailed as an example of the benefits of rigorous supply-chain-finance risk management.
Not this time.
The manufacturer didn't discover the problem until the supplier—facing severe cash-flow problems—closed shop, without warning, in the middle of an important project. It took the manufacturer eight weeks to find and qualify an alternate supplier and get the needed component. Luckily, the manufacturer was still able to deliver on time.
If the manufacturer's buyers had discovered the supplier's financial problems earlier, they could have deployed several strategies, including helping the supplier get needed financing. One option could have been working with financial markets to enable the supplier to borrow at the lower credit rates the manufacturer enjoyed.
Buyers and suppliers alike say such scenarios could crop up more often as the economy continues its downward drift. In fact, in its recent Economic and Risk Outlook Report, Dun and Bradstreet says that despite emergency actions of the U.S. Treasury and the Federal Reserve, there will be more business failures and an increase in late payments.
 Rudzki: “Purchasing has to partner with finance and treasury in their companies to stay on top of risks and plan strategies.” |
"We've seen many examples of suppliers going out of business, not due to bad business models but due to their cash flow freezing up," says Drew Hofler, senior manager of financial solutions at software developer Ariba in Sunnyvale, Calif. "That's adding a lot of risk to supply chains and buyers are more cognizant of this."
They are also becoming more cognizant of the broader issue of financial supply chain management, that range of strategies encompassing cash flow, earnings before taxes, risk management, procure-to-pay—and, in some cases, the actual financing of favored or critical suppliers.
Worldwide, procure-to-pay is the most commonly used method of financial supply chain management. But involvement in other areas is certain to grow, studies show.
Early in 2008, SAP partnered with consulting firm BrainNet to study the status of financial supply chain management from the perspective of purchasing leaders. Researchers conducted extensive interviews with 60 chief procurement officers and other senior executives from global companies. They studied CPOs' awareness of and involvement in working capital optimization, supplier risk management, supply chain financing, efficiency of procure-to-pay processes and even tax optimization, where companies try to lower total cost of ownership by leveraging different tax systems in the different geographies where they operate. They reached two major conclusions: Financial supply chain management is about to become one of the most important tasks of procurement professionals; and to effectively manage it purchasing will have to work a lot closer with finance. (See www.purchasing.com for a webcast on the SAP/BrainNet study.)
 Check suppliers finances to be sure they are stable. |
 Automate payments to suppliers—and ensure invoices match purchase orders. |
 Optimize cash flow and working capital. |
 Analyze suppliers’ markets and industries to see if there is trouble ahead. |
 Automate systems for request for proposals and request for quotes. |
 Help suppliers overcome problems in the credit markets. |
Finance is certainly changing. Ask Huntington Foam Corp. in Coraopolis, Pa. Says CFO Tom Kuehl, "there is more of a focus on cash management than on profitability than there was before. We are maintaining our financial health through this period."
The procurement and finance functions have a lot to learn from each other. For example, finance usually is deeply involved in working-capital management because it has the tools and knows the methods. Procurement, the BrainNet study says, is usually on the sidelines with working capital management except in specific cases, and the result is that its perspective on costs, risks and benefits stays hidden.
It begins with suppliers
For all its focus on heady concepts and business math—and the math can get complex—financial supply chain management begins with studying the suppliers themselves. "Purchasing has to look carefully at the finances of not only their tier-one suppliers, but of the tier twos and threes," says Robert A. Rudzki, president of consultancy Greybeard Advisors and former chief procurement officer at Bayer. "Buyers also have to partner with the finance and treasury officers in their companies to work out strategies such as the best payment terms for supporting corporate financial objectives, including the amount of working capital they'll maintain."
Analyzing suppliers' financial stability has always been an important part of strategic sourcing processes, but paying attention to suppliers' finances is especially critical in a time when credit is hard to come by. Like most of their OEM customers, suppliers often go to the credit markets for short-term financing to pay bills and long-term financing to expand their capacity. But with credit tight, they can fall short of the cash they need to pay their own suppliers—and that can mean delays in getting the materials and components they need to service their OEM customers. It's not a problem unique to America's shores. The Wall Street Journal reports that many Asian exporters are having difficulty getting financing because their banks fear their customers won't be able to pay their bills. ICIS.com reports that chemicals companies in Europe are facing ever-tightening credit.
The mix of tight credit and weak demand that's bedeviling companies worldwide could be behind a startling report from the administrative office of the U.S. courts, part of the federal judiciary. It reports that business-bankruptcy filings in the U.S. for the 12 months ending September 30, 2008 were up by 49% over the year-previous period. (The report lumped retail, finance and manufacturing businesses together.)
That's why some manufacturers are going out of their way to help their suppliers, including enabling them to refinance on the buyers' usually more favorable terms. Says Gregg Brandyberry, vice president of global procurement systems and operations at pharmaceutical giant GSK in Philadelphia, "These are tough times for suppliers, so paying attention to supply chain finance is important. There are some companies that actually act like banks for their suppliers."
But keeping suppliers solvent is only one use of supply chain financing. The SAP/BrainNet study said that other ways purchasing organizations might help their suppliers are to negotiate better prices, improve working capital, increase flexibility in pricing options, increase days payable outstanding and increase control.
Close relationships with and monitoring of suppliers can yield early warning of potential financial weakness. "We are seeing our customers monitor their suppliers' finances...in some cases it's been a reaction to the recent financial turmoil," says Huntington Foam's Kuehl.
Of course, financial scrutiny is not a one-way street. "Suppliers are looking at their customers' finances too," says Rick Jacobs, president of Eaton Filtration in Iselin, N.J., a division of Eaton Corp.'s hydraulics group. "You may wind up paying net 15 or net 20 if your suppliers are worried that they won't get paid at all if you don't pay them quickly."
Jacobs says there is one other thing that becomes obvious in tough economic times when some suppliers may be on shaky financial ground: Buyers suddenly realize that lowest cost isn't so important, especially if the supplier offering lowest cost is financially weak. "You may wind up paying more just to be sure you get the parts you need," he says.
Where that may be true for procuring materials and components, paying more is not necessarily a good thing when it comes to taxes. The SAP/BrainNet study revealed that tax optimization is generally not a concern of modern procurement departments, which would be no surprise to readers in North America. Still, the study says, in a global market companies in high-tax countries are at a disadvantage when competing with companies from low-tax countries. The study's authors say that because procurement controls so much of a company's spending there may be opportunities for purchasing departments to contribute to tax optimization. By aligning tax planning and procurement strategy, companies would be in a position to more effectively and efficiently manage their tax liabilities.
No more capital than you need
Beyond taxes and assessing suppliers' financial stability is the matter of working capital. The classic definition of working capital is current assets—cash, securities, receivables, inventory—minus current liabilities, including short-term debt, accounts payable, health-care costs and other liabilities, says Greybeard Advisors' Rudzki. Viktoriya Sadlovska, a senior researcher at Aberdeen Group in Boston, says her studies show that working capital optimization is among the top priorities in businesses today. Seventy-one percent of companies Aberdeen surveyed last summer cited it as a high priority. The shortage of working capital is a relatively higher pressure today compared to inventory- and business-expansion pressures, the study says.
So, what does working capital optimization encompass? It covers several strategies, according to the SAP/BrainNet study. Among them: make-or-buy analyses, extension of payment terms, leasing programs, fixed-asset utilization and, of course, procurement's old friend inventory management.
Remember that inventory makes up some of the current assets in the working capital equation, says Matthew Enderwick, assistant dean for finance and administration at North Carolina State University in Raleigh, N.C. and manufacturers want to keep their inventory as low as possible.
"Everyone is trying to reduce inventory," says Eaton Filtration's Jacobs. And, as is the case with credit concerns, inventory reduction is a goal for companies outside the U.S. too. "We ask suppliers to manage our inventory to save money," says Markku Vettenranta, head of purchasing operations for Helsingin Energia in Finland. "It's one of our main goals to be able to (have the suppliers hold the inventory and) get it just when we need it." Vettenranta uses Basware software to aid in management of purchasing and vendor-managed inventory activities.
Related to working capital is the matter of payment terms. Sadlovska says Aberdeen's latest study revealed that most companies surveyed were responding to tighter financial conditions by focusing on the short-term strategy of extending days payable outstanding. The study says that many companies are squeezing suppliers on payment terms and adopting less favorable terms with their own customers.
Extending days payable with suppliers can ultimately hurt suppliers, which depend on prompt payment to meet their own obligations.
Vettenranta takes another approach: paying within 14 days, usually. "We know suppliers rely on us," Vettenranta says, and adds that early payments can help suppliers reduce prices.
 Murphy: “We chase terms and will take discounts when offered.”  Dorion: “Good purchasing is like Six Sigma.” |
Tom Murphy, director of global procurement for test-equipment manufacturer Instron in Norwood, Mass., a division of ITW, says his company will pay suppliers early if they ask. "We always chase terms, meaning we go after 2%–10 days terms when offered," he says.
And Scott Dorion, director of procurement for ING Direct in Toronto, says his company always pays in 30 or 40 days. Discounts are not important to him. "We don't worry about discounts," says the Basware user. "We don't want to hurt our suppliers."
Joe Juliano, president of Atlanta-based PrimeRevenue, says that often procurement objectives on payment terms can conflict with broader corporate objectives. "Procurement may be looking for discounts, but corporate may want to extend payments, depending on how finance wants to use its cash," he says. Avoiding that conflict is another reason why purchasing needs to partner with finance, he adds.
Many companies have opted to extend payment terms, says Juliano. His customers upload approved invoices for selected suppliers onto his system, where suppliers can view the amounts and payment dates and decide if they want to wait for payment or trade the receivables for advanced payment. Ariba partners with The Receivables Exchange, where its customers can sell their receivables to institutional investors to get the working capital they need.
Whichever strategy purchasers adopt—extending payments or paying early and asking for discounts—they should resist the urge to focus on short-term wins, says Greybeard's Rudzki. "If all you do is focus on quick wins, you'll be in trouble when the economy starts to favor the seller."
ING's Dorion agrees. Too often, buyers focus on the tip of the iceberg. "They hammer the supplier. Instead, we should dig deeper into our supply chains to understand all the cost drivers—those that drive up suppliers' costs as well as those that drive up our own costs."
The best practice in tough economic times or good times is is to take a systems approach to purchasing. Good purchasing practices are like good Six Sigma, he says. "You need to look for efficiencies and eliminate things that raise costs for you and your supplier."
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