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Home » Blogs » Think Tank » Understanding the Link Between Finance and the Supply Chain

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Understanding the Link Between Finance and the Supply Chain

January 14, 2019
Robert J. Bowman, SupplyChainBrain
Understanding the Link Between Finance and the Supply Chain
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If you’re a supply-chain executive seeking advice on shoring up your company’s financial condition, be careful about who’s doling out the advice.

Certain “experts” in corporate financial practices will tell you that the answer lies in slow-paying your suppliers. Think of all the things you can do with that money before finally handing it over, they say.

What they won’t tell you about are the long-term consequences of stretching out payment terms – things like an interruption in the flow of critical materials because a supplier went broke for lack of cash.

“It’s very narrow thinking that’s perpetrated by finance and treasury [advisers],” says Lisa M. Ellram, Rees Distinguished Professor of Supply Chain Management at Miami University’s Farmer School of Business in Oxford, OH. “If you want to extend payment terms, it’s ‘free money.’”

That’s not the view of Ellram or her co-editors of Supply Chain Finance: Risk Management, Resilience and Supplier Management, a compilation of perspectives on the topic. (The other editors are Wendy L. Tate, William J. Taylor Professor of Business at the University of Tennessee’s Haslam College of Business in Knoxville, and Lydia Bals, Professor of Supply Chain and Operations Management at Mainz University of Applied Sciences in Germany.)

The book takes a dual approach to financial management across the supply chain: a short-term focus on accounts payable and receivable, and a broader perspective on working-capital optimization through inventory and asset management. Some two dozen writers address such issues as mapping and managing the financial supply chain, commodity management, cyber risk, blockchain technology and cash flow optimization.

“Those who really value their supply base and want long-term relationships are all about understanding how much the cash costs different people, and whom they should be paying more quickly and slowly,” says Ellram.

She cites the example of Honda, which continued to pay key suppliers weekly or even more frequently during the last recession because it viewed those vendors as being at risk.

Ellram and her fellow editors saw the book as a means of conveying the message that “there is an opportunity for companies to be more competitive, but only by thinking about [supply chain finance] holistically.” The first chapter, focusing on risk and resilience, demonstrates how companies can calculate the cost of extending payment terms, and the ultimate impact of that practice on the organization.

Even getting suppliers to accept less money in exchange for early payment can have a long-term negative impact on their stability and reliability. “Whoever is paying the cost is going to recoup that somehow, whether in bad service, hidden hostilities or higher cost,” says Ellram.

There are times when adjusting payment schedules to suppliers makes sense. It all depends on the supplier’s and buyer’s respective cost of capital. Walmart stretched payment terms to suppliers of slow-moving goods, while simultaneously offering financing in the form of early payment in exchange for a discount. For a small or medium-sized supplier to the giant retailer, the cost of capital can run 10-12 percent, even backed by bank credit. Walmart’s cost of capital, by contrast, might be 2-3 percent. The gap gives smaller suppliers an incentive to accept a discount.

Variable discounting “is back in style,” says Ellram. “My big concern is that a lot of people haven’t done the simple math to understand how much this really costs them. They just see that they’ll get their money faster.”

Third-party intermediaries offer another solution to satisfying the needs of both suppliers and buyers. They get the buyer out of the business of financing, and take that liability off its books.

Supply-chain financing by entities other than traditional banks is an area that has grown dramatically in recent years, drawing substantial amounts of venture capital, Ellram notes. It’s especially attractive to smaller companies due to a relative lack of regulation and oversight. On the other hand, suppliers and buyers need to carefully vet prospective non-bank financing sources, to ensure that they’re stable and adequately funded.

Supply-chain finance is a discipline in constant flux. A sudden shift in economic conditions can force companies to pursue a completely different approach to managing their money.

The prospect of higher interest rates, for example, is “a huge potential issue,” says Ellram. “You’re going to start seeing more people pushing back on their financing, and evaluating it more closely.” Suppliers could decide that they can no longer accept delayed payment terms due to a higher cost of capital. In a time of increasing economic uncertainty, even the best-laid finance strategy should be considered provisional.

Many companies are only just beginning to understand the link between finance and broader supply-chain risk, Ellram says. Even now, some treasury and corporate finance departments remain unconvinced of the severity of the issue.

Ellram hopes her new book will help to advance awareness of the need for a new approach to supply-chain finance. In particular, she says, companies need to examine their relationships with key suppliers, to ensure their continuing stability and loyalty in both good times and bad.

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