Help leverage the credit facilities of your corporate customers to finance the working capital of their suppliers.

Financing a business was seen as quite straightforward with the cheap and easy money that was available. This is no longer true. Clients failing to pay on time or extending payments terms are risking the survival of many suppliers. Liquidity has been the loser since the credit crunch started and the impact on these smaller enterprises is now being seen.

The supply chain of an organisation is part of its strategic advantage and any break in the supply chain has the ability to severely impact the organisation. Even with this risk there are few cost effective financing options available to the smaller corporate.

Supplier Finance provides a solution

What alternative financing options are available to the supplier that will not force a cost increase through to the buyer? Without effective supplier financing the buyer, regardless of their size, will be affected by the collapse or inability of a supplier to supply.

Supplier financing is one of the true win-win solutions in the market, it could even be referred to as the win-win-win. The supplier wins because they have access to non-recourse financing at a more competitive rate; the buyer wins because it is a key component of a working capital optimisation programme; and the financial institution wins because the acceptance of this new product is much higher than traditional financing solutions, therefore generating a new revenue stream.

Supplier finance is new! Some would say it has been in operation for many years but there are a few distinguishing features of the new model. Multi-currency funding limits, full web visibility, audit controls with post-trade financing available to the supplier on a non-recourse basis are among the new features.

Supplier financing is seen as an important tool in global trade. It offers transparency within the corporate. For the first time there is a financing solution that can be streamlined to allow current financial information, such as supplier invoices and sales invoices, to be made available. Financial risk should be reduced as financing is based on the actual trading of the company and the parties in the chain are more transparent.

Corporate STP is the cherry on the cake?

When it comes down to corporate straight through processing (STP) a corporate that has an efficient back office can take full advantage of supplier financing. It is now becoming an incentive for the corporate to drive for STP in the financial supply chain and eInvoicing is a key component of this. 

eInvoicing is only one process in the financial supply chain but it is a start that will support the move to the full digitalisation of the back office processes and the ability to fully integrate through the chain for full financial supply chain STP.   

Why not get it all?

All in all, today, borrowing money has become harder and more expensive for many enterprises. Money needed to fund the working capital of the enterprise. Naturally, they will look for a banking partner that could help solve this problem.

TietoEnator’s Supplier Finance solution will help leverage the credit facilities of your corporate customers to finance the working capital of their suppliers. In addition to increasing your clients STP, supporting their financing needs and lowering your risk, it helps you to generate a continuous revenue stream from every financing agreement. TietoEnator’s Supplier Finance offers all your clients a solution that will encourage them to continue see you as their primary banking partner.

Guidelines for letters of credit are set up in Article 5 of the Uniform Commercial Code. Letters of credit are important for business entities and individuals alike. When a business is attempting to purchase goods, services and technology to serve their clients, a letter of credit is essential. Most businesses do not pay cash or write a check for large purchases. When contacting new vendors, the letter of credit allows the vendor to see that the business is credit worthy and pays their bills in a timely manner. The vendor can then take on very little risk in forwarding the goods or services to the business organization without obtaining payment up front.

 The letter of credit also, at times, guarantees the seller that the money will be received even if the purchasing business defaults – a guarantee of funds. The same goes for a person who wishes to know how much of a mortgage they can afford before searching for a new home. The bank reviews the potential buyer’s financial situation and issues a letter of credit to a potential seller or real estate agent that the buyer is indeed credit worthy and not wasting everyone’s time touring homes, requesting information and asking questions. In this manner, the seller and agent are assured that should the buyer be truly interested in making a purchase, the bank will back them up with a mortgage and help them obtain the necessary funds.

Don’t let what has happened in the stock markets (locally as well as globally) these past few months give you a false impression that normalcy might be returning to China manufacturing…it remains a brutal operating environment for manufacturing.

Tightening in the credit markets continue globally, declines in demand remain in most industries, and competition is becoming much more intense.  And….you can take it to the bank….the same consolidation and restructuring that is taking place elsewhere in the world will certainly happen here in China…and the pressure will be on Procurement professionals to know how to select those suppliers that will be among the survivors.

Concerns Going Forward

I believe Supplier Disruptions is likely in most industries.  BBK has a financial rating process subscribed by over 50 multinational clients and has assigned risk of financial distress for 7000+ individual suppliers globally since 2007.  With regards to Chinese manufacturers, 15% are now considered as financially distressed. This is up from 9% in 2008.  As a comparison, 40% of Korea suppliers are now financially distressed versus 27% in 2008.

Another concern is that current economic crisis is rapidly accelerating consolidation in many industries.  There are simply too many companies operating in virtually every industry here in China.  There are 100 wheel suppliers in China with enough capacity to supply wheels for 100 million vehicles per year.  The biggest Logistics provider in China has 2% market share.  The top 10 players in the pharmaceutical industry have only 13% market share. The top 100 automotive suppliers in China have only 50% of the market share.  The list goes on.  In most every industry, the supply base will consolidate 30% to 50% as industries align to consumer demand and economies of scale are created.

Lastly, I have a grave concern that lenders are starting to take more aggressive actions to exit companies & industries in some cases…Let me share one recent example of what I am referring to.

Any of us who have worked in purchasing knows painfully well how a distressed supplier, which runs out of cash and can no longer maintain product shipments, presents some unique challenges.  Recently, one multinational OEM who was dependent on continuity of supply from a distressed Chinese supplier had to face such a situation.  The supplier’s sales were heavily dependent on export.  It had high debt levels, experienced a substantial drop in sales, and was exposed to rising raw material costs…. consequently, it generated large operating losses, violated its bank covenants and did not generate enough cash to service its debt.  The banks exercised their security interest in all of the supplier’s assets, including its inventory, and stopped all customer shipments.  The banks recognized the OEM’s dependence on the supplier and demanded “hostage” payments above the contract price to release shipments.  Although the OEM only needed a portion of the supplier’s inventory it was forced to pay premiums for shipments needed while it developed a replacement supplier.

We see lenders taking much more aggressive actions than in previous times.

Financial Health of Chinese Suppliers

Let’s start with the obvious…suppliers saw less sales growth Year over Year in 2008 versus 2007.  Significant sales growth covers up lots of operating problems or debt issues. Suppliers that are solely dependent on domestic volumes are better than the averages & those suppliers that are heavily dependent on exports are worse than the averages.
……………………………………………………….
2007     2008
Sales Growth (YoY)    77%      25%
Net Income/Sales       7.6%      3.7%
……………………………………………………….

Net income as a % of sales reduced from 7.6% in 2007 to 3.7% in 2008….not surprising. An interesting point about profit margins in China is that in most of the industries we follow, the Tier 1’s/Tier 2’s have higher margins than do the OEM.
……………………………………………………..
2007   2008   2009
Liabilities to Equity  1.4      2.0      1.6
Quick Ratio*               1.2      1.0      0.8
……………………………………………………..
*Current Assets less inventory / Current Liabilities

Here we are looking first at the ratio of total liabilities to equity. A slight deterioration from 1.4 in 2007 to 1.6 currently can provide an indication that Chinese firms, relative to their owner’s investment, took on more liabilities such as borrowings or extended trade payables.  This trend is important to note since it is more difficult for companies with high leverage to access additional capital which could be needed to weather a downturn. Liabilities to Equity ratio of 3.0 can usually lead to problems in accessing additional borrowings.

The quick ratio represents a company’s current assets (such as cash, accounts receivable, but not inventory…I want to talk more about inventory in a minute) divided by its current liabilities (such as accounts payable, debt payments due within the year or tax liabilities). In 2008, the quick ratio of Chinese firms deteriorated to 1.0 from 1.2 in the prior year and is currently averaging 0.8.  It is worth noting that a ratio of less than 1.0 implies that a company does not have enough current assets to cover its near-term payment obligations.  A company who’s quick ratio declines close to this level represents a higher risk of distress since business changes, such as a customer requiring longer payment terms, suppliers demanding quicker payments, or declining sales place additional strains on a company’s liquidity. While the two financial metrics illustrated here are not sufficient to fully evaluate an individual supplier’s health, the noticeable degradation over this sampling of suppliers sends a signal that the global downturn has impacted the financial health of Chinese suppliers and could threaten their ability to maintain a reliable supply….
……………………………………………………………………..
2007  2008
Accounts Payable (in Days)            92    57
Accounts Receivable (in Days)       89    79 
………………………………………………………………………

When we look at what has happened to changes in Accounts Receivables & Accounts Payables, on average, most suppliers have been paying their suppliers quicker than previously….most likely pressured so by many of their suppliers…and is a cause for deterioration in working capital at several companies.  Purchasing organizations are requested to target matching up payment terms to suppliers with those payment terms agreed to with their customers.  You certainly don’t like paying your suppliers before you get paid by your customer.
……………………………………………………………………
Supply Base            Inventory Turns*
China                           3.1
Korea                          13.7
Japan                           9.7
US/ Europe                 12.0
…………………………………………………………………….
*Annual Sales / Inventory

Lastly, let’s look at inventory. With the increased pressure on balance sheets and Cash Flow being more critical now than ever, we see Inventory Management as perhaps the single greatest opportunity for operational improvement and, an area where many Chinese Manufacturers should begin to immediately focus their attention!

Here we are comparing inventory turns for Chinese companies versus their counterparts elsewhere in world. Inventory turns is measured as Annual sales / Inventory (Finished, WIP & raw material).

Chinese suppliers significantly lag the performance of its peers in other countries. Reducing inventory levels frees up cash and improves a firm’s liquidity which is most crucial in this environment.  For many firms this also reduces its need for bank borrowings and their associated interest expense.  One of the first places we look for improvement in financially distressed companies is Inventory Management

Proactive approach to supply base viability will save significant RMB in costs

As many companies rethink how to structure their Chinese operations into their overall global supply chain strategy, most are concluding that a comprehensive Supply Risk Management (SRM) process that proactively monitors and validates the financial and operational viability of a supply base is essential for identifying distressed suppliers early.  The earlier the problem is identified, the more time a supplier has to find a solution or look to a new source to protect the customer from substantial revenue loss due to production interruptions or delays. Customers need to evaluate its suppliers’ financial and operational viability both prior to awarding the contract and on a regular basis thereafter. This requires understanding aspects of the supplier’s business that they might be hesitant to share, such as profitability levels.

SRM is critical for companies with the potential for supplier problems that could affect performance and delivery and for companies who have an inability to source from another supplier to prevent disruption. This may be due to suppliers with proprietary processes, the need to move customer-owned tooling, or simply the time necessary to contract and validate with a new supplier.

For those suppliers that are deemed “high risk”, an action plan to mitigate the risk should be tailored to the specific situation.  Some risk mitigation tactics include:
• Regular monitoring of the company’s financial health 
• Building safety stock inventory 
• Identifying alternative suppliers
• Working with the supplier to develop and implement operational and financial improvements.

While each distressed supplier may present unique challenges, the benefit of averting a crisis can help your firm protect its bottom line. 

China’s commitment to a loose monetary policy will likely generate as much as 8 trillion yuan (US$1.17 trillion) in new loans this year – well above the 5 trillion yuan target, analysts said.

Though the expanded credit could help turn around declining economic growth, some analysts see potential pitfalls on the horizon. The surge in loans together with expected strong growth in investment by the government and businesses will challenge the country’s ability to combat asset bubbles and industrial overcapacity, economists said.

It will also put greater pressure on the long-term credit quality of the commercial banks, they added.

China will maintain a relaxed monetary policy and ensure sufficient liquidity in the banking system to sustain economic growth, the People’s Bank of China said in a statement on Sunday.

The message dampened speculation that the central bank may step in to restrain credit after data showed on Saturday that fresh yuan-denominated loans and money supply surged to record levels last month.

“The credit growth was out of everyone’s expectation,” said Gao Yi, a senior macroeconomic analyst at Orient Securities. “Now it’s clear. The central bank won’t tighten in the second quarter or even in the third. That means credit growth can hit 7 trillion to 8 trillion yuan this year.”

Banks in China extended a record 1.89 trillion yuan in domestic-currency backed loans in March, bringing total new credit for the first quarter to 4.58 trillion yuan. That’s close to the government’s target of at least 5 trillion yuan for the whole year.

Thanks to the explosive credit expansion, M2 money supply, which includes all cash and deposits, jumped by a record 25.5 percent last month, compared with a government target of 17 percent.

The central bank said in the statement that it will “maintain continuity of its present monetary policy and ensure that money supply is sufficient to meet the needs of economic development.”

The tone may indicate that, although there was better-than-expected performance in the first quarter and liquidity was plentiful, the government is still concerned that conditions are fragile and the external environment will remain troublesome.

“It’s a really difficult challenge to run monetary policy right now,” said Stephen Green, head of China research at Standard Chartered Plc. “If you tighten too early, you risk choking off the recovery. But if you tighten too late, you run the risks of asset bubbles developing again and a lot of wasted investment.”

Other analysts also fear that if banks don’t increase oversight of loan approvals, credit quality may deteriorate as debt is dished out too quickly and some of the money may sneak into the stock market.

“Under such extremely hot conditions, we have doubts about the banks’ abilities to manage the overall loan quality and to ensure that the money will be used in an efficient way,” said Wu Ke, an analyst at the Zhongtian Investment Consulting Co.

Analysts are now playing down the need for imminent reductions in lending rates and banking reserve ratios, but they did say rate cuts are still possible in the second quarter as preemptive government measures to prevent deflation.

“The recovery is still very fragile now. We think the government will maintain relaxed macroeconomic policies for the next few quarters,” Goldman Sachs analysts Helen Qiao and Yu Song said in a note. “But if economic activity figures are lower than expected in the coming months, we expect interest rates to drop.”