Financial Supply Chain Management
Supply chain financial management
Supply chain management definition
- All facilities, functions, and activities associated with flow and transformation of goods and services from raw materials to customer, as well as the associated information flows
- An integrated group of processes to "source," "make," and "deliver" products
- The system of suppliers, manufacturers, transporters, distributors, and vendors that exists to transform raw materials to final products and supply those products to customers
That portion of supply chain which comes after the manufacturing process is sometimes known as the distribution network
Types of supply chain
1. Physical supply chain
2. Financial supply chain
Physical supply chain refers to the movement of goods as was described earlier between the initial supplier to the ultimate customer.
Financial supply chain refers to the movement of funds resulting from physical supply chain
Integration of FSCN with physical supply chain
Financial supply chain integrates with physical supply chain in multiple places with activities largely around payments and loans.
Generally banks provide these services some time other agencies also provides
Goal of the SCM
SCM is concerned with the efficient integration of suppliers, factories, warehouses and stores so that merchandise is produced and distributed.
-In the right quantities
-to the right location
-at the right time
In order to
-Minimize total system cost
-Satisfy customer service requirements
Need for financial supply chain management
Benchmarks of business performance indicate that enterprise resource planning (ERP) systems and other enterprise technologies have transformed customer and supply chain processes but that the performance of the finance function has hardly changed. Although some companies have managed to improve the performance of their financial processes profoundly, financial functions are still neglected in many businesses, and day's sales outstanding (DSO) and working capital needs are very high in several industries. The working capital scorecard for 2008 from CFO Magazine demonstrates that there are significant differences between high and low performers within an industry. In the automotive industry, for example, the best score in DSO was 44, while the worst score was 241—five times more than the sector median of 47. Research from the Hackett Group indicates that finance department costs continue to consume more than 1% of revenues in many companies, and CFOs struggle with poor transparency of their daily cash flows
In times when unprecedented economic uncertainty and soaring stockholder expectations are putting every function under closer scrutiny than ever before, the finance function should be driving business, not holding it back. Financial supply chain management (FSCM) can help companies to remove some of the inefficiencies in operational processes in order to become more effective.
Definitions of Financial Supply Chain Management
There are different definitions of the term financial supply chain , which appeared for the first time in 2000 and 2001. According to the research company Killen & Associates (2001), the financial supply chain "parallels the physical or materials supply chain and represents all transaction activities related to the flow of cash from the customer's initial order through reconciliation and payment to the seller." The Aberdeen Group, another research company, calls the financial supply chain "a range of B-to-B trade-related intra- and inter-company financial transaction-based functions and processes [which] begin before buyers and suppliers establish contact and proceed beyond the settlement process." The two definitions emphasize different topics. Killen's focuses on the parallelism between the physical and the financial supply chain, and it stresses a section of the cash flow collaborative nature of financial supply chain management and reveals that the financial value chain isn't limited to the inner walls of a company but includes communication and cooperation with business partners
Both definitions focus on a process-oriented view of the financial supply chain that is basically correct; however, in many respects the explanations do not go far enough:
They focus very much on the collaboration between companies—specifically, suppliers and customers—and they do not consider other important business partners within the financial supply chain, such as banks.
They describe primarily the status quo, and do not stress the various dimensions for the optimization of business processes within the financial supply chain.
The motivation, as well as the key , for an efficient financial supply chain are not obvious.
Another definition that includes these three aspects is the following: Financial supply chain management (FSCM) is the holistic and comprehensive planning and controlling of all financial processes which are relevant within a company and for communication with other enterprises. The goal of FSCM is to increase the transparency and the level of automation of business processes along the financial value chain. The purpose is to save processing costs and reduce the working capital of the company. This definition doesn't consider where the financial supply chain actually begins and ends, because there are also analytical processes that are not directly related to a business process but which belong nonetheless to the financial supply chain
Key Performance Indicators
There are various key performance indicators that are relevant for measurement in financial supply chain management. One key metric is the cash flow cycle, which defines the period from delivery by suppliers until the cash collection of receivables from customers (Figure 1). It is the time period required for the company to receive the invested funds back in the form of cash. The cash flow cycle can be divided into the operating cycle—which is the time period between delivery by suppliers and the actual cash collection of receivables, and the cash flow cycle—which is the time period between the cash payment for inventory and the cash collection of receivables. The longer the cash flow cycle, the greater is the working capital requirement of a company, which means that a reduction of the cash flow cycle will immediately free up liquidity
Within the cash flow cycle we can differentiate the following parameters,
Days in inventory: This is the length of time between the delivery of the goods and the invoice from the supplier, and the sale of the goods and the invoice to the customer. It describes the average number of days the goods of a company remain in inventory before being sold. This metric is the focus for all activities around classical supply chain management
Days in payables: This is the length of time between delivery of the goods and the invoice from the supplier, and the actual payment for the inventory. This figure describes the average time it takes to pay a supplier. The parameter considers the outstanding receivables of a company, and is an important metric for debtors concentrating on their efforts to optimize the purchase-to-pay cycle.
Days sales outstanding: This is the length of time between the sale of the goods and the invoice to the customer, and the actual payment date of the customer. This metric measures the average number of days companies need to collect revenue after a sale has been made. A high DSO number means that an enterprise is selling to its customers on credit and taking longer to collect money. The figure is an important figure for creditors, to optimize the order-to-cash cycle- Days in receivables: This is the length of time between the sale of the goods and the invoice to the customer, and the expected payment date. This key p performance indicator is similar to DSO, and indicates the average time, in days, that receivables are outstanding. Days in receivables can also be called best possible DSO, since the company would collect all receivables before the due date
Within the cash flow cycle there is potential to reduce both days in inventory and days sales outstanding. Days in payables can be increased but should be monitored carefully to avoid putting supplies at risk. Days in receivables can be reduced by optimizing cash collection. Another important indicator for an efficient financial supply chain management is working capital, which is a balance sheet metric and part of the liquid assets. working capital is calculated as current assets less current liabilitites, and is a measure of the liquid reserve and short-term solvency of an enterprise, available to satisfy contingencies and uncertainties. One of the key objectives of financial supply chain management is to optimize the working capital by reducing, for instance, outstanding receivables.
Supply Chain Flows
A supply chain is a network of partners that produces raw materials, subassemblies, and finished products, then distributes them via various sales channels to customers.
Along this chain, there are three major flows:
material, information, and financial
Financial Flows in the Supply Chain
Invoices and Payments
The financial flow in a typical supply chain includes thousands of invoices and payments in a given year. The scale of this problem is challenging corporations to find ways of streamlining their processing. There are also considerable savings to be obtained in other categories besides processing improvements. Any single organization in the supply chain has both Accounts Payable (A/P) and Accounts Receivable (A/R) activities. Each invoice is an A/P from the downstream buyer's perspective and an A/R from the upstream seller's viewpoint. Multiple invoices, however, are often paid by a single payment. This requires information as to which specific invoices are covered by a remittance. Also, when invoices are reconciled prior to payment, the three-way match of purchase order (P.O.), shipping receipt, and invoice may fail if all documents are not precisely consistent. Both of these potential failures can often be dealt with by innovative payment solutions with pre-established tolerances for automated processing
Information Transfer
Financial flows also include information transfer via Electronic Invoice Presentment (EIP) and electronic payments. This combination constitutes the Electronic Invoice Presentment and Payment (EIPP), an advanced payment application that automates specific financial tasks, as well as provides the opportunity to collect, aggregate, and share valuable information across the supply chain. Until recently, information and financial flows were treated separately. However, innovative payment solutions can now include detailed transaction information such as date and time of receipt, supplier name, quantity received, P.O. number, etc. Having both financial and detailed product information available electronically can minimize human errors, reduce reconciliation time, and create a more tightly integrated supply chain. Importantly, banks can aid customers in ensuring that reconciliation and posting to General Ledger (GL) is integrated automatically
Supply Chain Management Challenges
Despite the fact that companies have made a large number of significant supply chain management improvements over the past decade, there are still some unique challenges affecting operational efficiencies and service. The challenges listed here are those most closely related to what is commonly known as the "bullwhip effect," a term that refers to amplifications of end-consumer demand as one moves up the supply chain. How a company mitigates the bullwhip effect depends on the cause
CHALLENGE: Information Distortion
SOLUTION: Ensure rapid information exchange along the chain
One cause of the Bullwhip Effect deals with information distortion. If consumer sales increase by 5 percent in a given week, a retailer could end up ordering 7 percent more product in response to the increase and a feeling that demand will continue. The next link in the chain, observing what appears to be a 7 percent increase in demand, then orders a larger increase on his supplier. Eventually the factory may observe an inflated 20 percent increase in orders
Delays in transmitting changes regarding demand or supply can amplify problems. A good way to deal with this situation is to share point-of-sales (POS) information
with all partners in the chain. Emerging electronic payment (e.g. card-based solutions) and information management tools provide a new way of sharing information.
SOLUTION: Vendor-Managed Inventory (VMI)
Another way to deal with information distortion involves giving the supplier "decision rights" regarding the timing and quantity of replenishments. While many buyers may have concerns about turning these decisions over to suppliers, there have been numerous
successful pilots and full-scale applications of this concept, called Vendor-Managed Inventory (VMI).
CHALLENGE: Miscommunication
SOLUTION: Collaboration and Integration
Companies along the supply chain are more collaborative compared to the past. They are sharing forecasts and attempting to operate in a highly integrated fashion so that the end customer perceives the entire supply chain as fully integrated. Collaboration can take
several forms. A simple sharing of forecasts between supply chain partners can often avoid miscommunication about special promotions or other events that will affect demand. More complex integration can take the form of VMI
Information Transfer
Financial flows also include information transfer via Electronic Invoice Presentment (EIP) and electronic payments. This combination constitutes the Electronic Invoice Presentment and Payment (EIPP), an advanced payment application that automates specific financial tasks, as well as provides the opportunity to collect, aggregate, and share valuable information across the supply chain. Until recently, information and financial flows were treated separately. However, innovative payment solutions can now include detailed transaction information such as date and time of receipt, supplier name, quantity received, P.O. number, etc. Having both financial and detailed product information available electronically can minimize human errors, reduce reconciliation time, and create a more tightly integrated supply chain. Importantly, banks can aid customers in ensuring that reconciliation and posting to General Ledger (GL) is integrated automatically
Financial Flow Management Challenges
Most companies require significant amounts of Working Capital to deal with variable and somewhat unpredictable financial inflows and outflows. When viewed collectively, the financial flow management challenges such as slow processing, unreliable and unpredictable cash flows, costly processes, high Days Sales Outstanding (DSO), and suboptimal credit decisions require higher Working Capital than necessary.
If these challenges were removed, the money saved could be shifted to more valuable uses. In order to strategically address and minimize financial flow challenges and take appropriate action, one must first identify and evaluate the common causes.
Manual Processes
Manual processes tend to be slow, unreliable, unpredictable, and in the final analysis, often more costly than automated solutions.
Lack of Timely Information
In many situations, financial flows do not contain sufficient detailed information for either manual or automated systems to accomplish their jobs. As a result, additional time and effort is required to obtain missing information (e.g., invoice-level detailed
information such as SKU numbers, item quantities, and P.O. numbers).
Lack of Employee Empowerment and
Spend Policy Compliance
If purchasing by individuals isn't carefully monitored and controlled, inappropriate spending may occur, undermining the company's initiatives to control expenses and improve strategic sourcing. Strategic sourcing requires companies to know how much they are purchasing from various suppliers for different categories of product. Performing periodic analyses to create reports to help monitor spending and negotiate strategic sourcing with key vendors may be time-consuming and costly if this data is not captured electronically.
Delays in Invoice Reconciliation
Delays in invoice reconciliation are a particular cause of additional Working Capital; they delay receipt of payments and increase Days Sales Outstanding (DSO) of receivables. When there is a three-way mismatch of invoice, P.O., and shipping receipt, there is an inevitable delay while the mismatch is investigated. These investigations typically take time, as well as add cost.
Processes for Setting Optimal Limits
Companies often maintain their own departments to set customer credit limits. However, the ability to set optimal credit limits may require sophisticated algorithms that are often inaccessible to non-financial companies.
What's happening in
Supply Chain Management
Several trends and innovative best practices in supply chain management are now being observed in forward-looking companies. These include
Shared Services, Group Procurement
Companies that formerly had independent purchasing and payment operations at multiple sites are moving to a "shared services" model that centralizes these functions. The major benefits of shared services include economies of scale and increased quantity discounts from suppliers. availability on the store shelf for the end consumer They may also measure their average response time to special orders, as well as their worst-case response time.
Supplier Web Portals for Inventory Data
Many companies are instituting Web portals where suppliers can view inventory levels at the customer's site and POS or consumption data on materials. In order to implement Vendor-Managed Inventory (VMI), it is necessary that the supplier gain access to
the customer's inventory and consumption data. Such portals can also contain status information regarding the supplier's invoices.
Sophisticated Supply Chain Planning Systems
Modern supply chains have multiple levels, and it is often inefficient to manage each level independently. Various companies have installed sophisticated supply chain planning systems to replace separate layers of independent decisions.
Extended Performance Measures
Progressive companies today work as part of an integrated supply chain and measure product
Collaboration Along the Chain; VMI
Leading companies are working closely with partners along their supply chain to try to implement VMI. The evidence speaks loud and clear that VMI generally lowers inventories across the supply chain, increases higher product availability, and improves revenues.
Expanded Service Offerings
Often, a company may be asked to perform a new service by one of its customers. Enlightened companies are studying such opportunities to determine if they
will lead to improved profitability. If so, they may decide to offer the expanded service to all of their customers, thereby increasing profitability and also providing a closer attachment with current customers
What's Happening in financial cial Flow Management
Several trends and best practices are emerging for financial flows that will help to streamline and create end-to-end electronic payments. These include:
Purchasing Cards and Distribution Cards
More and more companies are installing Purchasing Cards (P-Cards) as a way of making purchasing more efficient and cost-effective. P-Card systems also enable companies to aggregate spend data quickly and frequently, and to maintain compliance with company spend policies They also increase financial transparency and help companies adhere to regulations. The Distribution Card is designed to re-engineer Distributors' and wholesalers' accounts receivable (A/R) process through the replacement of cash, customer credit and promissory notes. By shifting the manual-driven process and burden of invoicing and collections from the Distributor to the Bank, the Distribution Card transforms the collection process into a quick paperless electronic payment, reducing accounts receivable (A/R) costs substantially. Sales proceeds can be immediately transferred into working capital for faster turnover.
EIPP (Electronic Invoice
Presentment & Payment)
Gradually, companies are moving toward Electronic Invoice Presentment (EIP) and Electronic Invoice Presentment and Payment (EIPP). In a recent survey, 78 percent of respondents said they were either "very likely" or "somewhat likely" to transition from paper checks to electronic payments for their B2B payments within the next three years.2 Today's new EIPP tools provide an excellent opportunity to perform financial flow and information flow tasks at the same time. The ability to send detailed invoice-level information (SKU numbers, quantities, PO numbers, etc.) along with remittances enables the supply chain to transfer this information quickly and without errors often found in
manual procedures.
Invoice Imaging
Some companies are creating soft copy images of paper invoices so that all payments can proceed along an electronic, paperless pathway. Others are creating data warehouses to maintain line item detail, with information from a P-Card solution or other sources.
Supplier Web Portals for Invoice Inquiries
Another signifi cant trend is to develop Web-based automated inquiry systems for suppliers. Instead of accessing a call center to make a simple inquiry, suppliers can access a Web portal for their company and perform self-service inquiry regarding the status
of their invoices (received, in payables queue, in reconciliation queue, scheduled to be paid as of a certain date, etc.).
Web-based Financial Reporting
To reduce costs, significantly improve spend management, and make more informed business decisions, many companies are finding that it's critical to electronically capture financial transaction and invoice-level data and then review it through a Web-based reporting tool. This transaction and invoice-level data may be easily integrated with
existing back office financial systems. Research indicates that this integration capability can save 1-4 days per month on manual data synthesis and reconciliation activities
KPIs for Supply Chains
Product Supply Chain metrics have three key dimensions:
• Customer service is usually measured by percent Fill Rate or percent Complete Order Rate in a build-to stock situation, or by percent On-time Delivery in a build-to-order case. Increasingly for build-to-stock situations, companies are also measuring Product
Availability (percent time in stock) at retailers' shelves as a metric for customer service.
• Inventory (an Asset) is measured by value, by time supply (Days of Inventory), or by Inventory Turns (Turns = Cost of Goods Sold (COGS)/Inventory Value). All three metrics are closely related. By knowing a firm's annual COGS, one can derive any
inventory metric from either of the others.
• Speed is often measured by the Cash-to-Cash (C2C) cycle (C2C = Inventory + A/R – A/P), all measured in days of supply.
A negative C2C cycle is attractive for growth. However, taking the entire supply chain perspective, one's suppliers presumably become accustomed to delayed payment terms and find other ways to manage profitability. Furthermore, one company's payables are another company's receivables, and in the supply chain view, these "cancel out" with one
another. However, the integration of automated payment solutions can lead to a significant reduction in the uncertainty of A/P and A/R flows, which can ultimately be quite valuable to the entire chain
KPIs for Financial Flows
Key Performance Indicators (KPIs) for financial flows include the following:
• Days of Working Capital (DWC) =
(Working Capital/Annual Revenue) x 365
• Days Sales Outstanding (DSO) =
(Accounts Receivable/Annual Revenue) x 365
• Days of Inventory (DIO) =
(Inventory Value/COGS) x 365
• Days Payables Outstanding (DPO) =
(Accounts Payable/Annual Revenue) x 365
Days of Working Capital can be easily converted into an equivalent metric, Working Capital as percent of Annual Sales. (For example, if a company's DWC is 50 days, then Working Capital as a percent of Annual Sales = 50/365 = 13.7 percent.)
Other important characteristics of financial flows are:
• Reliability of payment methods
• Predictability of payment inflows and outflows;
improving cash flow
• Information Management (invoice-level data with
financial data)
Key How Supply Chain & Financial Flow KPIs Connect for Greater Efficiencies
In many cases, financial flow KPIs can have a direct, positive impact on supply chain management performance.
Impact on C2C
The financial flow KPIs of DIO, DSO, and DPO have a direct correlation to the C2C cycle supply chain metric. Improvements in supply chain design and operation may pay off in reduced inventory levels, thereby improving this metric. Additionally, modern
payment systems such as EIPP may pay off in reductions in both A/R and A/P for companies along the supply chain. Here, the benefit would be in reduced Working Capital needs.
Impact on Service
Expedited financial flows support a smooth-running supply chain. Conversely, if a delay in financial flows causes delays in material receipt, then customer service (fill rates, availability, on-time delivery) can be unexpectedly degraded.
Impact on Inventory
Financial flow processes associated with A/R can also affect the supply chain. There may be instances where unexpected delays in cash receipts force a company to delay ordering of incoming materials, due to Working Capital constraints. This could result in reduced customer service later on, when the absence of the missing materials is felt; it could result in higher stock outs, lower on-time deliveries, and decreased revenues.
Improvement opportunity for finance flows
Adopting automation solution for financial clows such as Purchase card and distribution card and EIPP systems creates improvement opportunities and cost saving in several areas.
More Efficient Purchase & Sales Processes
P-Cards have provided significant reductions in purchasing processing costs. Studies show a 50 to 60 percent reduction in A/P invoice processing from electronic systems.6 Another advantage of P-Cards is that they can be easily synchronized with company
expenditure policies. Merchant Category Codes can be used to direct purchases to vendors on a company's Approved Vendor List (AVL). There may be dollar
spending limits set on any single purchase, which can vary by individual. To improve sales and collections processes a seller may receive settlement of funds as soon as the next day by accepting a P-Card and and/or a Distribution Card as a payment method.
Faster Reconciliation through Electronic
Invoice Presentment (EIP) and Payment (EIPP)
Electronic Reconciliation – A/P
Matching shipping receipts, invoices, and corresponding purchase orders has been a manual process for A/P in many companies. It is not uncommon to have mismatch rates between 10 percent and 25 percent of all invoices received. The buyer typically informs
the seller about the mismatch and may not make any partial payment on the invoice until the discrepancy is resolved. It may seem that the buyer is gaining "fl oat"
or the use of Working Capital until resolution occurs, but since the cause is a document mismatch, there is no way the buyer can plan on that fl oat systematically.
Furthermore, from a supply chain viewpoint, the uncertainty associated with the delay in invoice payment until resolution may create difficulties for the seller. Electronic means of improving the three-way matching process are emerging. Companies that have moved
in this direction will typically perform the three-way match much earlier in the process. It is no longer necessary to wait until the invoice is due; the match can be performed immediately after the material has been received and a count performed. (Quality checks
can be done in parallel.) If a discrepancy is found, then there is ample time to correct it without delaying payment beyond normal terms, since the reconciliation has been initiated much earlier in the process. Furthermore, modern EIPP systems can provide sufficient invoice-level detail so that many mismatches can be quickly diagnosed with the information provided electronically. This speeds up the reconciliation process
significantly and accomplishes it at much lower cost. Electronic Reconciliation – A/R
Electronic Reconciliation – A/R
The same three-way match discussed above is also present on the A/R side. Companies can easily have three-way match discrepancies on the A/R side of between 10 percent and 40 percent of invoices sent. It may take up to 40 days to resolve the discrepancies. The company may receive only a partial payment on their invoice during this period, and sometimes no payment at all, until the discrepancy is resolved With automated systems, reconciliation can be accomplished earlier, more easily, and faster. Modern e-payment systems can include detailed information such as P.O. number, Invoice number,
and sufficient invoice and P.O. line item details to resolve many mismatches without further manual effort. The result is significantly faster cash inflows (e.g., a better Cash-to-Cash cycle) and reduced Days Sales Outstanding (DSO). Furthermore, automated
A/R processing can improve customer relationships
Improved Flow of Information
Data Integration
Use of P-Cards allows companies to obtain detailed data that is very helpful in the reconciliation process and could also be useful in the product supply chain.
While all card transactions contain "Level One" information (the minimum needed to clear and settle the financial transaction), modern systems allow for "Level Two" and "Level Three" data capture and transaction reporting. In particular, Level Three data
may include invoice-level details such as discount amount, freight/ship amount, order date, account number, item commodity code, item description, quantity, unit of measure, and unit cost.
Vendor Web Portals
A vendor Web portal allows vendors electronic access to a company's information records pertaining to their company, such as invoice status. Modern e-payment systems can contain sufficient detail to allow many vendor inquiries to be handled by a self service vendor portal. This saves both buyer and seller time and expense; it reduces telephone calls to the buyer and provides a faster response to the seller.
Outsourcing Credit and Collections
Credit Limit Optimization
When setting appropriate credit limits for customers, a number of different factors come into play, including account profitability and credit risk. Monitoring credit limits dynamically is difficult for companies to accomplish by themselves. There are economic
efficiencies in outsourcing the task of determining optimal credit limits and monitoring them dynamically. Not many companies can claim their core competence is optimizing credit limits. This business function is a natural candidate for outsourcing to a financial institution. Such institutions have specialized staff to deal with assessment of credit risk, as well as standardized collection procedures. Due to economies of scale, they may be able to provide this function in a more cost-effective manner.
Receivables Financing
If a company or an industry has traditionally had lengthy payment terms (e.g., 90 days or more), the suppliers will often want to have their receivables financed. This is another opportunity for banks to provide value.
Collections
Companies are also using Distribution Card solutions to streamline their collections and reconciliation tasks.Selling can be more effective when banks manage collections duties.
Lower Working Capital Needs
Improved financial flow processing can contribute to reduced Working Capital through better visibility. More effective financial processing can help remove uncertainties in financial flows and thereby contribute to a significant decrease in the Days of Working Capital (DWC). It has been estimated that increased visibility into A/R can reduce working Capital needs by as much as 20-25 percent.7 One way to estimate the impact of better visibility is to draw a parallel between managing Working Capital and managing inventories. Safety stock in inventory systems is proportional to the standard deviation of the demand forecast error. Improvements in supply chains can often lower the effective standard deviation of forecast error by 10-20 percent. Applying this logic to Working Capital, one would expect that improved visibility on both A/P and A/R could translate to reductions of 10-20 percent. One industry source forecasts that sophisticated cash-flow optimization tools will appear by 2006-07, adding significant enhancements to current innovative payment capabilities
Strengthened Partner Relationships
Closer, Responsive Customer Connection
Automated systems to submit invoices and receive payments make it easier for customers to reconcile and pay invoices. The ability to send Advance Shipping Notices (ASNs) and to track customer orders (dynamic order status information) can further cement the relationship between a company and its customers. Differentiate by Adding Services (e.g., EIPP) When a company provides a product that is not easily differentiated (e.g., a commodity), it can use financial services to differentiate itself from competitors. If a
company uses EIPP, it is much easier for customers to do business with that company because EIPP benefits accrue to both parties in the supply chain. If a buyer is considering two alternative sources of product, the company offering the EIPP benefi ts could be in a better position to win the business.
What's Happening in
Financial Flow Management
Several trends and best practices are emerging for financial flows that will help to streamline and create end-to-end electronic payments. These include:
Purchasing Cards and Distribution Cards
More and more companies are installing Purchasing Cards (P-Cards) as a way of making purchasing more efficient and cost-effective. P-Card systems also enable companies to aggregate spend data quickly and frequently, and to maintain compliance with company spend policies They also increase financial transparency and help companies adhere to regulations. The Distribution Card is designed to re-engineer Distributors' and wholesalers' accounts receivable (A/R) process through the replacement of cash, customer credit and promissory notes. By shifting the manual-driven process and burden of invoicing and collections from the Distributor to the Bank, the Distribution Card transforms the collection process into a quick paperless electronic payment, reducing accounts receivable (A/R) costs substantially. Sales proceeds can be immediately transferred into working capital for faster turnover.
EIPP (Electronic Invoice
Presentment & Payment)
Gradually, companies are moving toward Electronic Invoice Presentment (EIP) and Electronic Invoice Presentment and Payment (EIPP). In a recent survey, 78 percent of respondents said they were either "very likely" or "somewhat likely" to transition from paper checks to electronic payments for their B2B payments within the next three years.2 Today's new EIPP tools provide an excellent opportunity to perform financial flow and information flow tasks at the same time. The ability to send detailed invoice-level information (SKU numbers, quantities, PO numbers, etc.) along with remittances enables the supply chain to transfer this information quickly and without errors often found in
manual procedures.
Invoice Imaging
Some companies are creating soft copy images of paper invoices so that all payments can proceed along an electronic, paperless pathway. Others are creating data warehouses to maintain line item detail, with information from a P-Card solution or other sources.
Supplier Web Portals for Invoice Inquiries
Another signifi cant trend is to develop Web-based automated inquiry systems for suppliers. Instead of accessing a call center to make a simple inquiry, suppliers can access a Web portal for their company and perform self-service inquiry regarding the status
of their invoices (received, in payables queue, in reconciliation queue, scheduled to be paid as of a certain date, etc.).
Web-based Financial Reporting
To reduce costs, significantly improve spend management, and make more informed business decisions, many companies are finding that it's critical to electronically capture financial transaction and invoice-level data and then review it through a Web-based reporting tool. This transaction and invoice-level data may be easily integrated with
existing back office financial systems. Research indicates that this integration capability can save 1-4 days per month on manual data synthesis and reconciliation activities
KPIs for Supply Chains
Product Supply Chain metrics have three key dimensions:
• Customer service is usually measured by percent Fill Rate or percent Complete Order Rate in a build-to stock situation, or by percent On-time Delivery in a build-to-order case. Increasingly for build-to-stock situations, companies are also measuring Product
Availability (percent time in stock) at retailers' shelves as a metric for customer service.
• Inventory (an Asset) is measured by value, by time supply (Days of Inventory), or by Inventory Turns (Turns = Cost of Goods Sold (COGS)/Inventory Value). All three metrics are closely related. By knowing a firm's annual COGS, one can derive any
inventory metric from either of the others.
• Speed is often measured by the Cash-to-Cash (C2C) cycle (C2C = Inventory + A/R – A/P), all measured in days of supply.
A negative C2C cycle is attractive for growth. However, taking the entire supply chain perspective, one's suppliers presumably become accustomed to delayed payment terms and find other ways to manage profitability. Furthermore, one company's payables are another company's receivables, and in the supply chain view, these "cancel out" with one
another. However, the integration of automated payment solutions can lead to a significant reduction in the uncertainty of A/P and A/R flows, which can ultimately be quite valuable to the entire chain
KPIs for Financial Flows
Key Performance Indicators (KPIs) for financial flows include the following:
• Days of Working Capital (DWC) =
(Working Capital/Annual Revenue) x 365
• Days Sales Outstanding (DSO) =
(Accounts Receivable/Annual Revenue) x 365
• Days of Inventory (DIO) =
(Inventory Value/COGS) x 365
• Days Payables Outstanding (DPO) =
(Accounts Payable/Annual Revenue) x 365
Days of Working Capital can be easily converted into an equivalent metric, Working Capital as percent of Annual Sales. (For example, if a company's DWC is 50 days, then Working Capital as a percent of Annual Sales = 50/365 = 13.7 percent.)
Other important characteristics of financial flows are:
• Reliability of payment methods
• Predictability of payment inflows and outflows;
improving cash flow
• Information Management (invoice-level data with
financial data)
Key How Supply Chain & Financial Flow KPIs Connect for Greater Efficiencies
In many cases, financial flow KPIs can have a direct, positive impact on supply chain management performance.
Impact on C2C
The financial flow KPIs of DIO, DSO, and DPO have a direct correlation to the C2C cycle supply chain metric. Improvements in supply chain design and operation may pay off in reduced inventory levels, thereby improving this metric. Additionally, modern
payment systems such as EIPP may pay off in reductions in both A/R and A/P for companies along the supply chain. Here, the benefit would be in reduced Working Capital needs.
Impact on Service
Expedited financial flows support a smooth-running supply chain. Conversely, if a delay in financial flows causes delays in material receipt, then customer service (fill rates, availability, on-time delivery) can be unexpectedly degraded.
Impact on Inventory
Financial flow processes associated with A/R can also affect the supply chain. There may be instances where unexpected delays in cash receipts force a company to delay ordering of incoming materials, due to Working Capital constraints. This could result in reduced customer service later on, when the absence of the missing materials is felt; it could result in higher stock outs, lower on-time deliveries, and decreased revenues.
Improvement opportunity for finance flows
Adopting automation solution for financial clows such as Purchase card and distribution card and EIPP systems creates improvement opportunities and cost saving in several areas.
More Efficient Purchase & Sales Processes
P-Cards have provided significant reductions in purchasing processing costs. Studies show a 50 to 60 percent reduction in A/P invoice processing from electronic systems.6 Another advantage of P-Cards is that they can be easily synchronized with company
expenditure policies. Merchant Category Codes can be used to direct purchases to vendors on a company's Approved Vendor List (AVL). There may be dollar
spending limits set on any single purchase, which can vary by individual. To improve sales and collections processes a seller may receive settlement of funds as soon as the next day by accepting a P-Card and and/or a Distribution Card as a payment method.
Faster Reconciliation through Electronic
Invoice Presentment (EIP) and Payment (EIPP)
Electronic Reconciliation – A/P
Matching shipping receipts, invoices, and corresponding purchase orders has been a manual process for A/P in many companies. It is not uncommon to have mismatch rates between 10 percent and 25 percent of all invoices received. The buyer typically informs
the seller about the mismatch and may not make any partial payment on the invoice until the discrepancy is resolved. It may seem that the buyer is gaining "fl oat"
or the use of Working Capital until resolution occurs, but since the cause is a document mismatch, there is no way the buyer can plan on that fl oat systematically.
Furthermore, from a supply chain viewpoint, the uncertainty associated with the delay in invoice payment until resolution may create difficulties for the seller. Electronic means of improving the three-way matching process are emerging. Companies that have moved
in this direction will typically perform the three-way match much earlier in the process. It is no longer necessary to wait until the invoice is due; the match can be performed immediately after the material has been received and a count performed. (Quality checks
can be done in parallel.) If a discrepancy is found, then there is ample time to correct it without delaying payment beyond normal terms, since the reconciliation has been initiated much earlier in the process. Furthermore, modern EIPP systems can provide sufficient invoice-level detail so that many mismatches can be quickly diagnosed with the information provided electronically. This speeds up the reconciliation process
significantly and accomplishes it at much lower cost. Electronic Reconciliation – A/R
Electronic Reconciliation – A/R
The same three-way match discussed above is also present on the A/R side. Companies can easily have three-way match discrepancies on the A/R side of between 10 percent and 40 percent of invoices sent. It may take up to 40 days to resolve the discrepancies. The company may receive only a partial payment on their invoice during this period, and sometimes no payment at all, until the discrepancy is resolved With automated systems, reconciliation can be accomplished earlier, more easily, and faster. Modern e-payment systems can include detailed information such as P.O. number, Invoice number,
and sufficient invoice and P.O. line item details to resolve many mismatches without further manual effort. The result is significantly faster cash inflows (e.g., a better Cash-to-Cash cycle) and reduced Days Sales Outstanding (DSO). Furthermore, automated
A/R processing can improve customer relationships
Improved Flow of Information
Data Integration
Use of P-Cards allows companies to obtain detailed data that is very helpful in the reconciliation process and could also be useful in the product supply chain.
While all card transactions contain "Level One" information (the minimum needed to clear and settle the financial transaction), modern systems allow for "Level Two" and "Level Three" data capture and transaction reporting. In particular, Level Three data
may include invoice-level details such as discount amount, freight/ship amount, order date, account number, item commodity code, item description, quantity, unit of measure, and unit cost.
Vendor Web Portals
A vendor Web portal allows vendors electronic access to a company's information records pertaining to their company, such as invoice status. Modern e-payment systems can contain sufficient detail to allow many vendor inquiries to be handled by a self service vendor portal. This saves both buyer and seller time and expense; it reduces telephone calls to the buyer and provides a faster response to the seller.
Outsourcing Credit and Collections
Credit Limit Optimization
When setting appropriate credit limits for customers, a number of different factors come into play, including account profitability and credit risk. Monitoring credit limits dynamically is difficult for companies to accomplish by themselves. There are economic
efficiencies in outsourcing the task of determining optimal credit limits and monitoring them dynamically. Not many companies can claim their core competence is optimizing credit limits. This business function is a natural candidate for outsourcing to a financial institution. Such institutions have specialized staff to deal with assessment of credit risk, as well as standardized collection procedures. Due to economies of scale, they may be able to provide this function in a more cost-effective manner.
Receivables Financing
If a company or an industry has traditionally had lengthy payment terms (e.g., 90 days or more), the suppliers will often want to have their receivables financed. This is another opportunity for banks to provide value.
Collections
Companies are also using Distribution Card solutions to streamline their collections and reconciliation tasks.Selling can be more effective when banks manage collections duties.
Lower Working Capital Needs
Improved financial flow processing can contribute to reduced Working Capital through better visibility. More effective financial processing can help remove uncertainties in financial flows and thereby contribute to a significant decrease in the Days of Working Capital (DWC). It has been estimated that increased visibility into A/R can reduce working Capital needs by as much as 20-25 percent.7 One way to estimate the impact of better visibility is to draw a parallel between managing Working Capital and managing inventories. Safety stock in inventory systems is proportional to the standard deviation of the demand forecast error. Improvements in supply chains can often lower the effective standard deviation of forecast error by 10-20 percent. Applying this logic to Working Capital, one would expect that improved visibility on both A/P and A/R could translate to reductions of 10-20 percent. One industry source forecasts that sophisticated cash-flow optimization tools will appear by 2006-07, adding significant enhancements to current innovative payment capabilities
Strengthened Partner Relationships
Closer, Responsive Customer Connection
Automated systems to submit invoices and receive payments make it easier for customers to reconcile and pay invoices. The ability to send Advance Shipping Notices (ASNs) and to track customer orders (dynamic order status information) can further cement the relationship between a company and its customers. Differentiate by Adding Services (e.g., EIPP) When a company provides a product that is not easily differentiated (e.g., a commodity), it can use financial services to differentiate itself from competitors. If a
company uses EIPP, it is much easier for customers to do business with that company because EIPP benefits accrue to both parties in the supply chain. If a buyer is considering two alternative sources of product, the company offering the EIPP benefi ts could be in a better position to win the business.
Conclusions
The supply chain financial flow is at a critical threshold of evolution. Current trends in supply chain and financial flow management clearly favor the use of automated payment solutions. Continued expansion in this area offers high potential for:
• Reducing significantly purchasing processing costs • Accelerating payment and invoice reconciliation • Reducing collections costs significantly and minimizing the number Days Sales Outstanding (DSO)
• Creating greater processing efficiencies in the procurement of goods
• Enhancing visibility, which means less uncertainty in accounts receivable (A/R) and accounts payable (A/P) and a reduction in Working Capital needs
The various payment solutions presented in this document offer companies a powerful automated system that can eliminate financial flow challenges in today's supply chain. Based on an analysis of available supply chain performance data and measures of impact (as defined in this Visa Commercial Solutions Industry Briefing), it is possible to draw some generalizations about the economic efficiencies and benefits that can be gained by improving financial flows with various innovative payment solutions. Quantitatively speaking, a company with $1 billion annual revenue could obtain an annual savings of nearly $10 million, or almost one percent of revenues.10 This projected savings represents more than 20 percent of typical annual profits for such a company. For a median Fortune 500 company, the annual savings could be as high as $81million—eight times as muchi
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Riverside Art - Somerset, MA
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