The Supplier Finance solution attempts to marry these incompatibilities by ..... Following due diligence, a further 16 s
Experts in the News Multinationals can provide financial entropy to their supply chain in Africa It is not uncommon to hear that, today, the most innovative companies across the globe are investigating or putting in place new financing structures that allow them to improve their working capital position and develop organic cash flows. With the supply chain expanding as a result of globalization, many companies have faced reduced capital availability and have been pressured to source new, more cost-effective ways of financing their working capital needs, improving their financial metrics and lowering their end-to-end costs.
Munir S. Nanji Global Transaction Services Head of Central and West Africa Trade Head Sub-Saharan Africa
Companies and their suppliers are under conflicting pressures to improve payment terms, reduce costs, and improve cash flow efficiencies. While buyers are extending payment terms to their suppliers, the suppliers often have limited access to short-term financing and, as a result, a higher cost of capital. The tightening of credit following the global economic downturn has only further contributed to the problem. The Supplier Finance solution attempts to marry these incompatibilities by addressing both the availability and cost of capital within the supply chain through financial intermediation. They enable buyers to benefit from longer payment terms, improved visibility of their cash flow, and a more reliable supply base; while sellers can leverage the buyer’s credit to reduce the cost of capital and source cheaper financing. Hence, in today’s world, there is no doubt that the potential for such innovative financing solutions is enormous. However, the ‘early adopters’ of these are typically best-in-class companies which operate in mature, highly sophisticated markets. Africa, at first glance, would seem to be a whole different story.
Adriana Morawska EMEA Analyst Global Transaction Services
Macroeconomic & Financing Trends: Africa Today On the one hand, Africa is gaining increasing importance as contributor to the world economy. The IMF’s 2009 Regional Economic Outlook; reports that between 2002 and 2007, sub-Saharan Africa’s output grew annually by 6.5%; the highest rate in more than 30 years. This is mainly caused by favorable international commodity prices, increases in international aid, and improved security in key areas of the continent. In addition, the so-called ‘magnifiers’ as explained by Vijay Mahajan in the book Africa Rising, affirm that the opportunity in Africa may be even greater than the actual numbers suggests. He mentions that rapid growth rates, record-high levels of private equity flows, a massive informal economy and remittances from a broad African Diaspora, are all elements that magnify the economic size of the continent and its 900 million people to a startling $1,000 billion GNI.
Despite the spreading out of the global recession, so far the region seems to have avoided the huge contractions and losses witnessed in many other countries. This quick recovery is due to the fact that for long, Africa’s financial systems have been less integrated into the global economy and are thus, able to help their host economies smooth the impact of the global turmoil. As a result, focus from governments and multinationals hit by the crisis, has been shifted, rather forcefully, to the once overlooked emerging markets such as Africa. On the other hand, the continent continues to be significantly underleveraged in comparison to other regions. With domestic debt accounting for just a fifth of total debt in the region, Africa’s shallow financial system remains the main reason for a limited expansion of domestic debt. A widespread concern of authorities across the continent is that their banking systems are not providing enough support to SMEs and new economic initiatives. Banks in most African countries remain highly liquid but reluctant to expand credit other that to the most creditworthy borrowers. The IMF reports that the ratio of bank credit to the private sector to GPD is in the range of 10 to 20 percent for most African countries with only South Africa, Mauritius and Seychelles recording higher ratios. A number of countries are even below this number, including Tanzania, Uganda and Zambia. The African Competitiveness Report 2009 explains that it is the absence of scale economies and the high risks due to weak and underdeveloped contractual frameworks and economic and political volatility that make credit expansion to smaller players unviable. There is a lack of infrastructure necessary to support these smaller customers such as lack of credit registries, collateral registries, well-informed financial sector policy and poor creditor rights. The high risks of banking in Africa, the lack of balance sheet strength to support competitive rates together with a lack of competition, also drive up banking costs, as reflected by high interest spreads and margins. This makes banking in Africa more expensive and less attractive compared to other regions of the world. Regional Distributions 25th percentile
East Asia
75th percentile
Europe & Central Asia Minimum
Median
Maximum
High-income Latin America & Caribbean Middle East & North Africa South Asia Sub-Saharan Africa 0
0.05
0.10
0.15
Source: Beck, Demirgüç-Kunt, 2009 Note: Sample size is 133 countries; data are for 2007. Net interest margins are calculated as net interest revenue divided by total earning assets.
As a result, and contrary to what the immediate perception would be, the proportion of corporate debt in Africa is far behind that of other emerging markets. Most companies in Africa still raise funds based on their own share capital.
Multinationals as Incubators of Change - The Credit Paradigm The strong reliance on self-financing in Africa also strongly limits growth. The new equity raised, mainly through reinvestment of profits or even owners’ resources, as it is the case for many African companies, is insufficient to finance growth and investments. Furthermore, as traditional sources of capital continue to dry up, companies must focus on redeploying their cash from within. Faced with an increased focus in further developing operations in the continent but at the same time, significant barriers to credit expansion to the private sector, Africa must turn to forms of working capital management as a way of proactively sourcing short-term financing. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to cover for upcoming expenses. The management of working capital involves managing inventories, accounts receivable and payable and cash to ensure optimal cash flows. Through this, they minimize the time that the firm’s cash is tied up in operations and unavailable for other activities. With credit available to only a few strong players, there are wide differences across the profiles of the African market participants and such relationships can only be sustained through building trusted partnerships between the weak and the strong players. On the one hand, we find Buyers that are very large and better risk-rated than their smaller, less creditworthy Suppliers and as such; there is virtually no credit available down the food chain. A lot of the companies that do not have the balance-sheet strength to seek bank finance are constrained and unable to optimize their working capital needs, unless they partner with the stronger players. This can be achieved through leveraging on the credit strength of their trade partners through factoring solutions. Credit arbitrage can be then, used to stimulate working capital and ensure the end-to-end supply chain remains financed across the board. Credit Arbitrage at Work Multinational in Africa (Buyer)
SME in Africa (Supplier)
Payment terms: 45 days after delivery Working Capital Financing Requirement: Multinational: GBP 1,000,000 – SME: GBP 500,00 Clean Loan
Supplier Finance
• Average Credit Rating: 3-
• Average Credit Rating: 6
• Cost of Working Capital Finance Facility (to pay Suppliers): LIBOR (e.g. 5.3%) + 1.5% p.a. spread
• Cost of Working Capital Finance Facility (to finance production): LIBOR (e.g. 5.3%) + 5.5% p.a. spread
• Total Cost of WC Financing: GBP 1MM, 45 days at 6.8% : GBP 8,500
• Total Cost of WC Financing: GBP 500M, 30 days at 10.8% : GBP 6,750
• Payment terms are extended to days, hence WC facility only covers the residual (any other WC financing requirement)
• Payment terms are extended to 70 days, while Supplier gets the money immediately
• Total Cost of WC Financing: GBP 500M, average 45 days at 6.8% GBP 4,250 • Cash is deployed from within the Supply Chain
• Total Cost of WC Financing: GBP 500M, 70 days, charge based on Buyer’s credit rating (6.8%): GBP 6,611 • Annualized savings for the Supplier of GBP 139 • Guaranteed Early Payment • Frees up credit lines to capture additional business with lenders
However, when comparing the key success factors of a successful supplier finance model in a mature market with that of African markets, it can quickly be noticed that a full ramp up of more ‘sophisticated’ forms of financing cannot help but to present a few challenges for its success in Africa. Africa still somewhat lacks the legal, operational and technological frameworks to support these transactions at a large-scale. Corruption, bureaucracy, political and economic instability exacerbate these further. The refined supplier finance models as delivered in Europe and the U.S today require information to be transparent, advanced technological platforms, debt collections to be customized from both technological and legal point of views and trade relationships to be consistent. In Africa, this is not always the case. However, things are rapidly improving. According to the IMF, financial systems across the continent have become deeper, more efficient, and more stable over the past decade. They have begun to diversify activities and expand their reach with new products and technologies. In addition, the increasing presence of multinationals in the continent and their focus on the region promotes good governance, looks for sustainable, long-term value and brings a strong push for a more transparent and efficient end-to-end process. A Win-Win Solution This ‘financial entropy’ allows for a win-win situation. African suppliers win from liquidity at rates they could never afford on a stand-alone basis and multinationals benefit from a much more oiled supply chain and a more reliable supplier base. Today, with advanced supply chain management, many multinationals have outsourced their supply chains such that they rely on the expertise of the suppliers to deliver the right quantity and quality at the required time. To achieve this, when operating in Africa, it is important for these types of companies to get suppliers closer to their business. In addition, it is important for them to have domestic suppliers due to issues that are prevalent in Africa such as logistics challenges, poor infrastructure, custom delays, landlocked territories, etc. The mutual partnership of multinationals and domestic suppliers brings several spill-over benefits like long-term value governance, labor creation, sustainable business and development. Supply chain finance solutions aim to optimize the availability and cost of capital within any given supplier-buyer supply chain by unlocking trapped value from it. According to the Aberdeen Group, it does this by aggregating, packaging, and utilizing various pieces of information generated during supply chain activities and marrying this information with the physical control of goods. The coupling of information and physical control enables lenders to mitigate financial risk within the supply chain. The mitigation of risk allows more capital to be raised, capital to be accessed sooner or capital to be raised at lower rates. To materialize this, the lender will purchase the receivables, on acceptance of the invoice by the buyer, thereby providing the supplier funds at a competitive rate at an earlier date than that of the formal payment date of the receivable. The bank will then receive full payment from the buyer at maturity.
Ongoing Relationships
Supplier
1. Purchase Order
Supplier
2. Goods Delivery
Supplier
3. Invoice
Buyer
4. Accepted Invoice 5. Payment
Bank 6. Payment @ Maturity
Supplier Finance aims to leverage on the trade credit paradigm by transferring credit risk from the weaker to the stronger players. It releases credit availability to those that if it was through clean lending, it could not reach. For Africa, it is certainly this particular aspect what makes it the most attractive of the supply chain finance solutions, as it addresses the lack of credit expansion to smaller players just about perfectly right. The credit risk rating that the lender uses is that of the buyer, so the price that the bank charges for this service is based on the creditworthiness of the buyer, not the supplier. Furthermore, from a bank’s perspective such solutions address the risk issues that prevented credit expansion Banks will always feel more comfortable dealing with counterparties that have stronger balance sheets, are able to provide guarantees, and have a sustainable long-term value proposition. Through these financing methods, banks are now able to facilitate the financial entropy by leveraging on the multinational’s standing and accessing the wallet of their supply chains. Over time, these relationships evolve and the ‘umbilical cord’ holding these players together breaks. These companies, once unable to obtain credit to sustain their operations and expansion, are now able to sustain themselves resulting in a wider scale economic benefit for all. A Success Story – Bamburi Cement Bamburi is part of the French building materials giant Lafarge and is the largest cement-manufacturing company in east and central Africa. The Challenge The objective of the program was to assure continuous supplies to Bamburi by providing working capital support to Bamburi’s key suppliers. The program also aimed to optimize Bamburi’s working capital cycle (i.e. stretching the payment period from 15 days for some of the suppliers to 30 days) without increasing cost to its supply chain, and to improve relationships with its suppliers. Bamburi had a tightly controlled supply chain designed to reduce borrowing costs. It continued to pay its suppliers and logistic partners on the invoice due date and tried to match its payments to its logistic partners and suppliers with receipts from customers in an effort to optimize working capital and reduce borrowing costs. As a result, payments to suppliers would only be made on the due date
and on occasion get delayed. Suppliers had to finance their operations with bank borrowing at high costs, given their relatively small size and limited collateral, causing financial distress and high costs. Ultimately, the suppliers’ additional cost of borrowing (due to increased days outstanding) led to them repricing their services to Bamburi. The Solution Citi proposed a supplier finance solution — the first of its kind in East Africa. Under the program, it paid Bamburi’s suppliers on the due date of their invoices by drawing on Bamburi’s credit facilities. While the interest cost was passed onto suppliers, the financing cost was lower due to the substitution of the suppliers’ credit risk for that of Bamburi’s. The solution therefore enhanced suppliers’ loyalty to Bamburi. Citi has committed to providing timely and efficient service to ensure the success of the program. Payment instructions received before 12 noon will be processed on a same-day basis; instructions received after noon, on a next-day basis. By supporting its suppliers, Bamburi was able to demand better payment terms and improve the efficiency of its working capital. Bamburi also benefitted from improved cash flow; its days payables were effectively increased because the final liquidation of the supplier finance loans were an average 30 days after the due date of invoices. The benefit of the increased days payables allowed Bamburi to extend enhanced credit terms to its distributors, giving it a competitive advantage. The Result Citi began a pilot implementation of the supplier finance solution with one supplier in August 2008, after working extensively with it to identify and eliminate potential implementation problems. Following due diligence, a further 16 suppliers were added to Bamburi’s supplier finance program. Bamburi estimates an opportunity for cost savings of over USD200, 000 a year, and it is considering expanding the program to its subsidiary in Uganda.
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