Financing the supply chain – A walk through the problem and its possible solutions

Article index

• Why financing the working capital is important
• The key role of large companies in a supply chain context
• Financing the supply chain is still a collaborative activity
• The instruments for the financing of the supply chain
• How to use the available instruments to finance the supply chain

• How to overcome the criticalities of the traditional approach: Polaris

1.  Why financing the working capital is important

Companies die when they no longer find a place on the market but they also die (much more often) when they fail to manage their operational financial cycle, when the time range 

between the payment and the collection stretches too much and the company does not find the financial resources to cover this gap. The short-term financial tension is probably the major crisis factor, sometimes irreversible, of Italian companies and is reflected in all credit risk scoring models, which tends to overweight the indicators that measure this phenomenon. It is true that this is a matter of short-term liquidity management that the company has (or has not) but, also and above all, of management of the factors that this liquidity generate (customer payments) or absorb (payments to suppliers).

The experience of recent years, widely documented by the annual research of the Observatory of Supply Chain Finance of the Politecnico di Milano, is that the trend of overall improvement in payment times recorded up to 2019 actually hides a progressive lengthening of the financial cycle of the smaller companies, which is offset by the improvement of the larger ones. This phenomenon is the result of several factors: on the one hand, financial awareness, and a more structured approach by the larger companies and, on the other, less bargaining strength by the smaller ones. However, the stretching of the range ends up affecting the creditworthiness of SMEs, further depressing the risk appetite of banks towards companies whose financial deterioration is perceived.

2.  The key role of large companies in a supply chain context

There is a limit beyond which the exclusive pursuit of the individual interest of the large company ends up drying up the socio-economic ecosystem in which it operates. This is true when we look at the environmental sustainability, but this is equally true whenever we look at the organizational ecosystem of the chains of production and supply.

Pursuing solely the individual interest is easy, but potentially very risky. A car manufacturer who pursues the unilateral optimization of its financial indicators runs the risk of finding himself with a sales network crippled by payments that are too short in relation to the turnover of its warehouse and with discontinuous production processes due to the difficulty encountered by the suppliers to finance their working capital. Both are transformed into negative market performances, consumer disaffection and, ultimately, sub-optimal financial results.

The large company that produces transformation plants all over the world and tries to finance itself by wringing the neck of its suppliers will soon discover that the deterioration in the performances of the latter makes the timely completion of the works more difficult and increases the incidence of delays and non-compliance, resulting in an extension of the payments of its customers. This is without mentioning that each supplier, in turn, chooses from time to time which customer to favour; such choice is based on drivers that are not just the combination of price and quantity but also punctuality of payment, availability of working capital financing instruments, operational integration, etc.

3. Financing the supply chain is still a collaborative activity

 The supply chain is an interconnected universe in which, in the medium term, there is no room for free riders.

The approach to supply chain financing as a system is necessarily a holistic approach which frames the individual interest of individual subjects within a framework of overall balance. From this point of view, it is an approach in which the responsibility falls mainly on the company at the center of its own ecosystem, whether it is the point of arrival of the production chain or the initial point of distribution of finished products.

The functioning of these complex ecosystems requires, among other things, a balanced management in the financing of their overall working capital and, therefore, the structural involvement of players unrelated to the supply chain relationship and its logistical implications, as are the financial partners (banks, specialized intermediaries, funds, credit insurance companies and, in general, all those categories of subjects able to ensure the liquidity of the system, based on creditworthiness assessments referring to individual counterparties and to the assets that can be monetized, taking into account the context of contractual and operational relationships).

Coordinating the interests of the different types of players involved in supply chain financing is a process that requires awareness of the complexities inherent in the approach of each subject.

From Buyer’s point of view, once the equilibrium price/quantity has been defined as acceptable, the financial theme is expressed in the opportunity of a duration of the commercial debt consistent with the transformation/sale/collection processes and in the evaluation of the available financing instruments, with their effects on the financial representation of company data [rif. Article SCF Arrangements].

The Supplier’s point of view is mirrored and potentially opposed to that of the Buyer.

The intervention of the financial Partners ensures the transformation of the contrast Supplier/Buyer into cooperative mechanisms, based on the combination of the credit capacity of the involved parties and the available technical instruments.

4.  The instruments for the financing of the supply chain

The following chart summarizes the instruments available for the financing of the working capital, with the related credit conditions and the accounting effects of the transactions, distinguishing the instruments that operate on the balance sheet liabilities (lines with a yellow background) from those that operate on the assets (lines with a blue background).

As shown, the range of instruments is wide, but this does not mean that they are within the reach of all companies.

The dimension of the company and the creditworthiness are important discriminators for the actual availability of use of many of those instruments. The company size is critical, for example, to guarantee economies of scale to financier who want to set up reverse factoring arrangements that present a sufficient diversification of the involved suppliers. The creditworthiness is a prerequisite for the active use of all the indicated instruments. The combination of the two discriminants draws a context in which, once again, it is mainly the large companies that have the possibility of using those instruments and, in particular, those that act on the liabilities side of the balance sheet.

5.  How to use the available instruments to finance the supply chain

However, true supply chains are not like the solar system of classical physics, characterized by a central body surrounded by smaller bodies, but constellations of different sizes stars that interacts with each other, exchanging goods and services independently of their relative size. This means that even medium-sized companies may find themselves playing the role of the focal point of individual supply chain segments, with the goal of optimizing the financing of company’s working capital and the piece of constellation of which they are the center. How to face the problem?

Some common sense rules.

1. The solution that works in all cases does not exists.
2. Mapping the main subjects of its own section of the supply chain, trying to evaluate their financial standing in relation to that of its own company. After that, trying to make the most of the creditworthiness of others (aiming for longer payment terms, for a supplier, or shorter, for a customer).
3. Identifying the weak points of the supply chain, not only from a logistical and production process point of view but also from a financial one. Evaluate the way to support the weaker elements (and set the conditions in order to replace them whenever the need arises).

The problem of usable instruments of support and of the overall balance objectives of the operating cycle to be pursued only arises at the last point. At this stage, company size, creditworthiness, assessment of the implicit operational impact in individual solutions and the constraints that those solutions carry with them, especially in a long-term logic, become topical again.

Some examples.

Objective: extension of the passive cycle and support to suppliers.

Solution 1 – Reverse Factoring

Solution 2 – Confirming

Solution 3 – Letter of credit

As it can be seen, there is no certainty that the abundance of instruments is likely to generate convincing solutions, mainly because those are sectorial solutions and linked to a specific partnership, with all the constraints of dependence that this entails.

6.  How to overcome the criticalities of the traditional approach: Polaris

Our walk ends then with a proposal, that of Polaris, which aims to overcome some of the typical limitations of traditional solution to supply chain financing.

Polaris is a digital platform to which all three key players in supply chain financing adhere to: Buyer, Suppliers and Financiers. Their adherence to a common contractual architecture determines the establishment of a permanent community over time and the sharing of information necessary to support the implementation of operations that are over time repeated. The engine of the community is the Buyer, which invites its suppliers to adhere, negotiate payment terms with them (with the possibility to ensure for himself some sort of elasticity), may associate suppliers and financiers, defining specific programs for individual segments, and providing to the platform the passive invoices that are payable upon completion of its internal control processes.

Polaris is open to the participation of various financial partners, who define the credit lines available for each individual Buyer and the relative prices.

In so doing, Polaris allows suppliers to access to credit offer of financial partners (and also of the Buyer, who can also set up dynamic discounting operations) in an absolutely dynamic manner and without any kind of constraint and manages the negotiation of the Buyer's commercial debt.

Compared to traditional solutions, Polaris offers an open, scalable solution that does not determines the dependence on single financial player and even allows the smallest and weakest suppliers to access the liquidity made available by the players who exist on the platform.

In its operation, Polaris absorbs all the financing instruments of passive working capital that were previously examined and allows the Buyer to use them in a flexible way in order to achieve its supply chain financing objectives, by associating them with the various clusters of suppliers and financial players.

Repeating the analysis exercise proposed above

Solution 4 – Polaris