Corporations as lenders / supply chain finance

Banks are very much the part of the financial universe under the spotlight at the moment. There are so many changes affecting them, from regulation, retail separation and political pressure on wages and bonuses, to euro zone pressure and recessionary risks of lending, that we are all becoming scared that they will not be able to act like banks and lend to corporations. Much effort, including from the ACT, is therefore to understand the implications of this and one path to follow is to investigate how non bank corporations might fill the gap left by bank lending.

Such sources of finance are now well identified, from Bonds (e.g. Retail and High Yield) and Private Placements to (the possibly also bank financed) Asset Finance and Supply Chain Finance. One such source of finance can of course be trading corporations, where many are now sitting on quite large chunks of cash. Many such firms retain their long term debt (or have no debt) but build up cash through quite strong cash generation combined with a lack of willingness to invest in either acquisitions or capital expenditure. In fact cash holdings of corporations are higher than they have ever been and to some extent the traditional role of a treasurer as a professional funder has been replaced by a treasurer as investor.

The treasurer therefore needs to understand the dynamics of this and this faculty looks at some of the practical and theoretical aspects of the non financial corporation as a lender, particularly in the supply chain.

We have been here before. In the UK in the 1980s it was quite fashionable to invest corporate surplus cash in finance leases, where there were substantial tax benefits. However, as treasurers acquiring such assets through M & A deals found out, they were far from liquid and frustration grew as the balance sheet ballooned with bank debt on the one hand and finance lease assets on the other.

Probably the most popular destination for today’s cash surpluses outside the conventional liquid assets such as Money Market Funds, bank deposits and bonds is in the Financial Supply Chain. Large companies are finding that their customers and suppliers are being squeezed for finance and it is an obvious use of surplus cash (and also a superior credit rating) to:

• Help customers buy your product
• Help suppliers source your inventory

The help can be focused and real value can be added, so that a customer that you help to finance can pay more for your goods. A supplier that you help can charge you less. We are all aware of the possible conversation with a car salesman.

Customer: I like that Porsche but it’s a bit beyond my budget.
Salesman: It’s an excellent car. It would be a shame for you to miss out on it because it’s very good value at that price. I think I can find someone who can help with finance. Let me see.

Salesman: Good news. I have just squeezed you in before the deadline for car finance applications this month. It’s one of the best deals I’ve ever seen.
Customer: Well, it would be silly not to take this opportunity.
Salesman: Would you like insurance too, sir?

It is worth putting down some points to consider if surplus cash is to be used to help the supply chain.

Cash investment runs on the acronym SLY, in that order:
S Security
L Liquidity
Y Yield

Each of these must also be considered in supply chain finance.

Security
Capital invested in either customers or suppliers must be safe. This is most important for customers where often long term finance is needed to ‘make that sale’. Treasurers must assess the creditworthiness of such customers as though they were a bank and must be prepared to say no. It might also be necessary to consider suppliers in the same light as risk is assumed in committing to few suppliers.

Liquidity
Liquidity is lost when investing in the supply chain (at least for many products) and this is probably the biggest problem with it. When the Chief Executive has the deal of a lifetime and the treasurer is scrabbling for funds, there will be unhappy customers and suppliers if arrangements are unwound.

Yield
It might be difficult to calculate the yield on such investment. Collaboration with operations is required and the results may not be stable, but supplier and customer loyalty might be hard to measure. Certainly, the yield must be compared to the WACC, or other hurdle rate, and not with cash investments. This has implications for financial management and corporate finance. Some of the benefit may appear as margin on sales, rather than as an interest benefit and this needs careful review.
Other important factors to consider will be:

Recording - Cash managers are good at recording investments in bank deposits, money market funds and so on. What are the implications for supply chain investments? Do treasury record this or is this a job for management accounts?

Working capital Large corporations have been fighting down working capital for years. Suddenly a different emphasis is required. Investors therefore need to be educated.

Banks - Many schemes rely on infrastructure from banks. How reliable are they and how easy are they to change?

Regulation - The shadow banking sector might be subject to regulation. Activities by corporations might fall into this category.

FX Controls - Some customers where loans might work well could be located in jurisdictions where payment of interest or principal might become difficult.

Risk - Is a proper procedure for risk management adopted, including measures, KRIs, KPIs and feedback etc.?

Anti silo - Is proper communication with operational management adopted?
New trends in finance often come with hidden shocks and Supply Chain Finance could be one of them.

By Will Spinney