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Why CFOs Should Adopt SCF to Meet Cash Requirements
CFOs today depend on the strategic function of treasurers than in previous years. One reason why treasurers’ role has become more aligned to the CFO’s agenda is a direct result of the treasurer’s ability to unlock value within the organization at a low cost, and drive strategic objectives of the CFO, such as offering a more comprehensive view of cash and payments, acquisition strategies and capital allocation strategies.
In fact, securing low-cost financing is arguably the corporate treasurer’s primary objective. Among their many responsibilities, ensuring adequate access to liquidity at the appropriate level of risk and cost is imperative for the success of their role. Luckily for treasurers, there is no shortage of banks eager to discuss various funding arrangements, again based on the probable risk and cost of the FI (financial investment). These funding arrangements will most certainly come at a cost to the treasurer, and drawing down to access the needed liquidity will likely be treated as debt on the balance sheet.
Consider SCF (supply chain finance) as a dynamic solution to remedy the issue. While not a new strategy, SCF has yet to fully penetrate the corporate market. In a recent survey conducted by Kyriba and Spend Matters, only 10 percent of polled treasury professionals cited an active SCF program at their organization. Therein lies a tremendous opportunity for treasurers and CFOs to gain a strategic market advantage by adopting this proven, liquidity solution.
Additional Reading: The Most Important Value That a Truly ‘Strategic’ CFO Can Deliver
What is a SCF program?
At its core, SCF, or more specifically reverse factoring, is an arrangement where the corporation (buyer) enlists with banks to make payments on their behalf to suppliers. Reverse factoring provides suppliers with early payment of approved invoices, but instead introduces a third party to deliver invoice financing. Reverse factoring offers an attractive alternative to factoring programs for sellers, by offering a lower discount and more flexible terms than they would achieve on their own. For the buyer, reverse factoring offers an opportunity to extend DPO (Days Payable Outstanding), improving working capital while not hurting the liquidity of key suppliers.
As an alternative to reverse factoring, dynamic discounting programs are best suited for corporates that have excess cash and liquidity. This type of program is designed for organizations looking for an alternative to low yielding short-term investments as these programs typically yield in excess of 10 percent APR. With dynamic discounting, buyers pay their suppliers early using their own funds. The early payment discount is calculated based on a pre-agreed financing rate and the number of days remaining until payment was originally due. The earlier the payment is made, the greater the discount realized for the buyer.
So how does a SCF program help drive a broader capital allocation strategy?
SCF programs, especially those housed within treasury technology that also leverage cash management workflows, can greatly improve free cash flow – interest free – via a term extension where reverse factoring is introduced to soften the impact to relevant suppliers. Treasurers are better positioned to satisfy committed share buyback, dividend, acquisition or related milestone payments, or debt buyback targets given the influx of cash flow following reverse factoring program deployment.
Thus, as the CFO pushes out DPO, the liquidity position improves at no financial cost and without additional debt on the balance sheet. This brings us to an important point: SCF alone is not the strategy, but rather the strategy of the corporation is to improve liquidity, and SCF is the tool to execute against this strategy.
Why SCF programs work
It is key to understand that the buyer will have a superior credit rating than their suppliers. A survey conducted by JPMorgan found that 65 percent of corporate suppliers are sub-investment grade. In addition, many suppliers face uncertainty as to when they will be paid from their customers, which puts a tremendous strain on these smaller companies and their ability to manage operations. Given these financial and operational factors, suppliers are eager to obtain low cost, predictable financing, and therefore we have a SCF market.
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