Most of us may be familiar with this quote by Warren Buffett: “Cash ... is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent.”
In many ways, this quote is a reminder to businesses on why managing cash and liquidity needs to be at the forefront of their business strategy, in both stable and volatile periods.
Recently, I had the opportunity to speak at webinars on topics such as cash management and conservation and supply chain finance (SCF). From my interactions with the participants, many companies shared similar concerns about their cash flows. And, this is not limited to small and medium enterprises (SMEs), but large corporates as well.
As we can see from the developments of the past few months, there were instances in which businesses that were once thriving and running smoothly are now grappling with day-to-day operational issues and, in some cases, considering closing down. With revenues dipping significantly over the past few months, cash conservation measures are being extensively explored by the business community.
The government has introduced several measures to help stimulate the economy and protect businesses. The latest, in early June, is one of the most comprehensive packages yet. Penjana, Malaysia’s RM35 billion short-term economic recovery plan, has three main thrusts to support the economy in the new normal, namely:
- Empowering the people,
- Propelling businesses, and
- Stimulating the economy
To propel businesses, the government is encouraging government-linked companies (GLCs) and large corporates to accelerate their vendors’ payment terms. This is aimed at providing relief for their SME vendors’ cash flows. However, this will put pressure on the GLCs and large corporates’ own cash flows. For example, large corporates that have long-standing payment terms of 45 days with their suppliers will now be required to pay within 15 days. Based on my conversations with clients, we are confronted with this question: Is this a sustainable solution or only a temporary stop-gap measure for the duration of our economic recovery?
This is where I believe SCF can play its role as a mutually beneficial solution for both the GLCs and large corporates, as well as their SME vendors while supporting the Penjana initiative in a sustainable way.
What is SCF?
SCF is defined by the International Chamber of Commerce (ICC) as the use of financing and risk mitigation practices and techniques to optimise the management of the working capital and liquidity invested in supply chain processes and transactions. The most common forms of SCF in use today are supplier finance (or reverse factoring) and dynamic discounting.
SCF, via supplier finance, is an innovative way for large companies such as GLCs to help their suppliers, especially those that are SMEs, obtain access to affordable finance without collateral. How can this be done? As a start, SME suppliers would be able to leverage the large buyers’ balance sheet or credit rating to obtain their working capital financing.
SCF also helps large buyers optimise their payment terms and improve supply chain stability; at the same time, their suppliers are able to enjoy the benefit of faster payments.
The evolution of SCF
SCF is not a new concept. It has been commonly used by large multinational companies (MNCs) in countries such as the US, UK and China for many years now. The automotive sector was one of the early adopters of SCF before it was explored by the retail sector in the 1990s. In the last several years, SCF took off and was implemented in various industries by leading corporations in the US, Europe and Asia-Pacific, especially in China.
While there is insufficient market data on the size of the SCF market, the SCF growth trajectory is encouraging. According to an article by The Global Treasurer last November, by some estimates, global SCF volumes reached US$447.8 billion in 2016 — a 36% increase from the previous year.
The International Finance Corporation (IFC), a member of the World Bank Group, has been actively promoting SCF over the last several years as a method to assist micro, small and medium enterprises. The IFC has identified some global trends driving the growth of SCF programmes, including:
- Evolution of global supply chains,
- Significant improvements in technology and automation of transactional processes,
- Participation of facilitators such as industry associations and credit insurance companies, and
- Supportive global regulations favouring supply chain financing, formalisation of definitions and recognition from bodies such as the ICC
Despite the growth and popularity of such programmes overseas, the awareness of SCF programmes in Malaysia appears limited, based on my discussions with local corporates. Predominantly, the knowledge of such programmes is confined to global MNCs that have a presence here as they would have implemented these programmes globally.
Despite the lack of awareness, it is interesting to note that we do have the ecosystem here in Malaysia to implement such programmes. Within the financial services sector, we can see SCF offerings by some foreign and local banks. Supporting infrastructure such as an electronic platform owned either by a bank or a third-party vendor (which supports multi-bank programmes) is also available. An SCF platform enables the programme to be digitised and connects the stakeholders (GLCs, suppliers and financiers).
Given the increase in SCF-related conversations I have had with clients in the past six months, I can foresee the adoption rate in Malaysia rising significantly in the next couple of years. Having said that, it is critical for companies to construct a fit-for-purpose SCF programme based on their unique needs and working capital requirements. It is also essential that proper due diligence is done internally before choosing your SCF programme partners, as the cost to plug into the programme is low but the cost to unwind the programme could be steep.
How does SCF work?
One of the easiest ways to explain an SCF’s supplier finance programme is through an illustration of the transaction flow (see chart).
Benefits to stakeholders
SCF programmes provide opportunities to all stakeholders involved (see table).
While the benefits to suppliers and the financial intermediary are consistent and accrue almost immediately, the pay-off to buyers may vary depending on whether the primary objective is to improve cash flow or to strengthen supply chain stability.
Based on our experiences, SCF programmes typically start off in a strategic manner, with the purpose of strengthening the supply chain. Strategic and financial benefits are accrued over a medium- to long-term horizon.
Given the government’s current Penjana initiative, it is timely for GLCs and large corporates to consider adopting SCF programmes now. Any early payment measures need to be implemented through a well-thought-out strategy, and with sufficient leeway for unintended consequences, in view of the constantly evolving business landscape.
By injecting liquidity into their supply chains through SCF programmes, GLCs and large corporates will be able to contribute in stabilising their SME partners while laying the foundation for future growth. The result is a lasting win-win outcome for themselves and their suppliers.
Ganesh Gunaratnam is working capital management leader at PwC Malaysia