Supply Chain Finance can be defined as optimizing the flows and allocation of financial resources in a supply chain. Supply chain finance schemes focus on improving supply chain efficiency (financial performance), effectiveness (delivery performance) and sustainability (social performance).
The majority of supply chain finance schemes are organized around working capital. Working capital is generally defined as the capital available for conducting the day-to-day operations. But, how do you calculate working capital? It is normally calculated as the excess of current assets over current liabilities, also called Net Working Capital (NWC). In most situations this means the sum of inventory and receivables minus payables.
Work capital finance solutions are typically based on one of the components of NWC and can be divided in pre-shipment, in-transit and post-shipment. This division is based on the following triggers in the purchase to pay (P2P) process: Purchase order (PO), shipment (invoice release) and receiving of goods (goods receipt).
This question is at the heart of working capital management. In business there are often consequences that need to be taken into consideration when deciding to change one or more working capital components.
Such changes may have positive or negative impact on suppliers or customers they trade with. Delayed payments to suppliers could affect the loyalty and reliability of suppliers. Allowing long payment terms to customers could increase the risk of non-payment. Reducing inventory levels without taking into consideration your production processes could reduce efficiency and result in additional costs. These working capital trade offs are at the heart of many business decisions because capital is often scarce and choices need to be made.
Companies employ working capital ratios to measure their working capital positions. Most commonly used are DPO (Days Payable Outstanding), DSO (Days Sales Outstanding) and DIO (Days Inventory Outstanding).
Companies that wish to improve their working capital will require a holistic perspective across the organization. It will need alignment between the operations, supply chain, sales, purchasing, finance and treasury function.
Moreover, companies will increasingly have to look beyond their own organization to optimize working capital. Furthermore, working capital loans should be organized across their supply chain. We have seen an increase in the development of such supply chain finance schemes such as reversed factoring, dynamic discounting and supplier financing.
To summarize you could say that managing working capital is in principal about managing the liquidity of a company. Companies that are cash constrained will make working capital management their top priority.
Companies participating in supply chains that are cash constrained will tend to seek collaboration in the form of supply chain finance schemes with customers and suppliers to manage the amount and predictability of their cashflow.
Now you know everything about working capital and its relation to supply chain finance. Would you like to participate in experiential learning about the topic working capital? Inchainge’s business simulation games are about learning the trade-offs between managing profit while also managing net operating working capital. It is about developing an intuition for the relationships between profit, cash flows and working capital. You will experience topics such as inventory, receivables and payables. Furthermore, it includes the options to add more complexity by including multiple currencies, risk events and sophisticated supply chain finance solutions.