the impact of supply chain finance on corporate performance improving supply chain efficiency and...

7/22/2019 The Impact of Supply Chain Finance on Corporate Performance Improving Supply Chain Efficiency and Increasing

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Master Thesis in MSc. Finance

Dan Xu Brentsen

The Impact of Supply Chain Finance on CorporatePerformance: Improving Supply Chain Efficiency and

Increasing Profitability

Advisor: Anders Thorstenson

Submitted 19 April 2012


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Acknowledgement

I am heartily thankful to my thesis advisor, Anders Thorstenson whose encouragement,

guidance and support from the initial to the final level enabled me to develop an

understanding of the subject and finish it successfully. It has been an honor to work

with him. Anders, your contributions, detailed comments and insight have been of great

value to me.

I would specially like to show my gratitude to the coordinator at Siemens, Alexander

Gorker who has been so supportive for giving me valuable suggestions, support, and

insights. Thanks Alexander with your kind help for practical knowledge. I contacted

you several times by emails for additional information and you always responded to me

right away despite your busy schedulesThank you very much for that.

Lastly, I offer my regards and blessings to all of those who supported me in any respect

during the completion of the project.

Dan Xu Brentsen

Business and Social Science, Aarhus University

April, 2012


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Table of Contents

Abstract ............................................................................................................................. 4

Chapter 1 Introduction ...................................................................................................... 5

1.1 Backgrounds and motivations ................................................................................ 5

1.2 Problem formulation .............................................................................................. 7

1.2.1 A general framework of research .................................................................... 8

1.2.2 Research questions ........................................................................................ 10

1.3 Research methodology ......................................................................................... 13

1.3.1 The research process ..................................................................................... 13

1.3.2 Hypothesis, testing methods and research questions .................................... 16

1.4 Delimitation ......................................................................................................... 17

1.5 Thesis outline ....................................................................................................... 18

Chapter 2 Literature review ............................................................................................ 18

2.1 The development of supply chains ...................................................................... 19

2.2 The link between supply chain and financial flows ............................................. 20

2.3 Supply chain finance ............................................................................................ 22

2.4 The integration of SCF into SCM ........................................................................ 23

2.5 Financing suppliers in the supply chain ............................................................... 25

Chapter 3 Financial supply chain management .............................................................. 26

3.1 Financial-SCM and the link to economic value added ........................................ 27

3.2 Integrating SCF into payable processes and cash flow cycle .............................. 28

3.3 FSCM performance indicators and profitability ratios ........................................ 31

3.3.1 FSCM performance indicators ...................................................................... 31

3.3.2 Key profitability ratios .................................................................................. 33

3.4 The impact of FSCM on corporate performance ................................................. 37

Chapter 4 Empirical Analysis ......................................................................................... 39

4.1 The sample selection and data description........................................................... 39

4.2 Hypothesis tests and testing methods .................................................................. 42

4.2.1 One-sample distribution tests and ttest......................................................... 43

4.2.2 Correlation and regression analyses .............................................................. 44

4.3 Data analysis and interpretations ......................................................................... 45

Chapter 5 Case study at Siemens .................................................................................... 52


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5.1 Supply chain finance at Siemens ......................................................................... 53

5.2 FSCM indicators, profitability and growth at Siemens ....................................... 57

5.3 Recommendations ................................................................................................ 63

5.3.1 Updates in the ERP system ........................................................................... 63

5.3.2 Control of payment terms and SCF loans to suppliers .................................. 64

5.3.3 Extension to emerging markets ..................................................................... 68

Chapter 6 Conclusions .................................................................................................... 70

6.1 Criticism ............................................................................................................... 70

6.2 Suggestions for future research of interests ......................................................... 71

6.3 Conclusions .......................................................................................................... 72

References ...................................................................................................................... 74

Appendix ........................................................................................................................ 78


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Abstract

The thesis studies the application of supply chain finance (SCF) in supply chain

management. The SCF is also called supplier finance, and mainly it is used to deal with

the financial issues in supply-side value chain management. The impact of SCF oncorporate performance reflects in the improved supply chain efficiency in terms of cost

saving payable processes and payment term extension. The performance indicators

derived from the financial supply chain management (FSCM) have influences on

profitability. On the SCF program, decreased costs of goods sold (COGS) obviously can

increase return on invested capital (ROIC) and return on equity (ROE) in short term.

The cause-effect relationships between the FSCM performance indicators and

profitability are established by the EVA model and tested in linear regression analysis.

The popularity of using the SCF program is increasing after the financial crisis (2008)

because of the imminent beneficial consequences. Small participants can take large

participants credit ratings to finance their capital requirements on the SCF program.

Together with early discount payment, the small participants are able to save financing

costs as well as increase cash and speed up cash flows. Large participants can extend

payment terms to attain positive cash flows and to increase economic value added.

Additionally, the large participants can leverage the small participants cost savings to

negotiate better price offers and in turn to reduce their own COGS. The supply chain

finance is a financial solution that provides win-win outcomes for all the participants in

the supply-side value chain. Particularly in the economic recession, the positive impact

of SCF on corporate performance can increase corporate economic power in the

marketplace and remain competitive.


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Chapter 1 Introduction

In this chapter, backgrounds of financial shortages in international supply chains and

motivations of using supplier finance to assist on supply-chain improvement are

introduced. The problem formulation includes a general framework of research andresearch questions. The research methodology includes research methods and the

research process. Delimitations about the critical choices are argued in order to magnify

the accuracy of research results. The structure of this paper is outlined at the end.

1.1Backgrounds and motivationsAlongside the trend of globalization, companies are oriented to produce international

product, which will be sold globally, thus coordinating with international suppliers all

over the world is inevitable. With this trend companies increasingly focus on their core

capabilities, effective and efficient supply chain management (SCM). It has become a

key constituent of corporate strategy, competitive advantage, and success (Narasimhan

and Talluri 2009).

Since 2008 the financial crisis has resulted lots of banks or financial institutions in

confronting serious credit risks, which subsequently bring liquidity tightening, bank

runs and even bankruptcies. Absolutely, this issue will affect their financing activities to

companies. In the meanwhile the international business has also faced to a big

challenge, because trading partners are ought to seek for alternative capital financing

sources or approaches. Dynamic discounting, early discount payment and lengthening

payment terms are crucial for corporates to deal with insolvencies and remain

competitive at the same time.

In the history of trade finance, factoring and letter of credit are often applied to help the

international business partners manage cash flows. However, the impact of financial

crisis will amplify counterparty risks and increase transaction costs. Problems of aging

payables and increasing credit risks have become the main reasons to cause inefficiency

in operational and financial performances.

The supply chain disruptions in relations to supplier defaults can have long-term

negative effects on a firms financial performance. Hendricks and Singhal (2005) show

that companies suffering decreases in 33-40% lower stock returns relative to their


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industry benchmarks because of supply chain glitches cased by suppliers. Furthermore,

the impact of supply chain performance on financial indicators has also been revealed

by Avanzo et al.(2003) from financial accounting points of view. The risks in the

supply chain management associated with volatility and supplier failure had increased

54% between mid-2007 and mid-2008 (Kerle 2010).The importance of supply chain

risk management is illustrated by the results of a recent survey, which reveal that 90%

of films felt threatened by supply-side risks (Snell 2010).

The whole supply chain contains the inbound and outbound logistics through business

processes from suppliers to final customers. Here, the study focuses on inbound

material activities with suppliers through manufacturing operations and financial

services with suppliers through the upstream flow of cash. Accordingly, the financialissues caused by the level of supplier-buyer relationships are considered as basic

assumptions to explore part of supply-side risks.

An empirical Demica report (2011) studies the growth trend of a financial solution on

supply-side trade relations. It is used to 1) improve cash flow management, 2) reduce

risks of supplier failures in supply chains and 3) improve transparency of transactions

between suppliers and buyers. Supply chain finance program has gained attentions since

the financial crisis. The SCF program aligns the third party financial services, large and

small participants through the open account. It is also called reverse factoring, and it is a

process that the large participants help the small participants receive lower cost of

capital financing by sharing credit lines. The SCF program provides also the early

discount payment to the small participants.

The introduction of SCF into SCM, i.e. financial supply chain management (Michael

2009) will help companies consolidate the competition in the marketplace by means of

generating real cash flow benefits. Farris and Hutchison (2002) emphasize a cash-to-

cash cycle time as an important indicator in supply chain management metric.

Additionally, Bhagwat and Sharma (2007) consider the total cash flow time as an

element into the balance scorecard (BSC) measurement model. However the failure to

relate key measures to performance drivers brings obstacles of applying BSC to track

the cause-effect relationships between performance indicators and further improvement

of corporate value.


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Lambert and Pohlen (2001) usethe EVA model to integrate the supply chain operational

processes to financial performance. Gomm (2010) embraces the key performance

indicators for both supply chains and financial flows in to a single corporate

performance evaluation based on the EVA model. The EVA model works also on

capturing how the companies drive value and profitability including the cost of capital

in the supply chain.

Wang (2010) has conducted an empirical analysis to test the impact of the SCF program

on corporate performance before financial crisis. The improvements of operational and

financial indicators can be observed in short term. Kerle (2010) has further provided the

evidences of maximizing the current scarcity of liquidity by applying the SCF program.

IMDs survey (2009) shows over half of respondents have admitted the implementationof SCF to SCM can help improve supplier relations1.

The positive outcomes by applying the SCF program in supply chain management are

recognized. The study interests of this thesis are to explore the impact of the SCF

program and the effects of development on short term corporate performance; the

impact around the time period of financial crisis is considered. The EVA model will be

used to identify the most important indicators and ratios, and build up their cause-effect

relationships. The SCF program is initiated by the large participants in supply chains, so

the improvement of their corporate performances is significant. Furthermore, reducing

supply risks in terms of enhancing supplier liquidity are also expected to be

investigated.

1.2Problem formulationIn this section, a general framework of research is created containing the financial issues

in supply-side value chain and the application of a financial solution for improvement.

The introduction of the SCF) program is able to help the international business partners

conquer financial constraints and develop cash flow efficiency. The subsequent research

questions are designed to explore the possibilities and to explicate the outcomes.

1http://www.imd.org/research/publications/upload/PFM178_LR_Ralf_Daniel_Seifert.pdf Supply Chain

Finance - Whats It Worth? ,www.imd.org,no. 178 October 2009.
http://www.imd.org/http://www.imd.org/http://www.imd.org/


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1.2.1 A general framework of researchIn the house of supply chain management in figure 1, there are two business partners

under the roof, one is the supplier and the other is the buyer. The buyer is considered

stronger than the supplier under the circumstances. The impact of financial crisisdestroys the usual balance of inbound logistic business processes between them, in

particularly the upstream flow of cash. Therefore, the lack of efficiency in supply chains

causes the difficulties in the flows of financial resources between organizations.

In order to increase liquidity, the supplier promotes terms on early discount payment

with cost of money and the buyer applies dynamic discounting method with upfront

cash reserves. This method works all right when the situation is not extremely downside

in the financial crisis. When the bank runs occur often and in turn affect the financing

activities to companies, the buyer starts to consider lengthening payment term in order

to fulfill internal financing on working capital needs. Indeed, the dynamic discounting

method is redundant for the sake of holding cash reserves. This phenomenon results the

supplier in complexity of managing its account receivables. Eventually the supplier will

borrow money from other financial factors with higher credit costs in order to further

operate the business processes. In the meanwhile it is not rational anymore for the

supplier to offer early discount payment, because the lower credit ratings may lead tobankruptcy at the end.

The consequence of supplier failures in the supply chain is expensive; hereby the

resolution to help the buyer and the supplier live on from the transitory overwhelming

turmoil is a further contribution of this study. The introduction of the SCF program in

the supplier-buyer trade relations breaks the door to the next level of supply chain

managementfinancial supply chain management (FSCM).


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Figur e 1: F inancial issues on supplier-buyer relationships in supply chain management and benefi ts

of applying the SCF program

Sources:Authors creation

Supply Chain Management

Supplier Buyer

Materials

Cash

Early discount

Payment

Higher cost of

capital

Worse credit

risks

Dynamic

discounting

Lengthen

payment terms

Risks of supplier

failures

Financial Crisis

Financial

Institution

SCF Programs

FSCM

Financial

Resources

SCF Programs

FSCM

Better financing cost (early

discount payment according

to buyers cost of money)

Alternate source of liquidity

(to securitize cash flow with

buyers credit rating)

Reduced disputes of payable

processes

More predictable cash flows

Improved credit rating to

avoid default risks

To negotiate payment term

extension with suppliers and

improve economic value

added.

Reduced operating process

costs and increased

standardization of process

Better cash flow

management

Improved supplier-buyer

relationships

Benefits for supplier Benefits for buyer


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We can see in figure 1, the application of the SCF program brings a new financial

solution to supply chain management, considering the third party financial services. The

reverse factoring allows the buyer to help the supplier receive better terms of capital

financing through the IT platform provided by the financial provider. The SCF program

is a superior solution for the supply-side value chain management.

Both the buyer and the supplier can benefit on the SCF program. Most importantly, the

buyer can pursue a tactic strategy to lengthen payment terms without extracting extra

costs from the supplier as well as improving the economic value added (EVA). As for

the supplier, lower cost of financing and speed-up cash flows are the most significant

achievements. Supplier risks are mitigated as the supplier strengthens its cash flow and

as a result it has a better liquidity which is especially helpful in the financial crisis;eventually the supplier can improve its credit rating and become stronger in the

marketplace.

The SCF program has the insight of becoming popular concerning the positive

outcomes from the perspectives of both the buyer and the suppler. The financial crisis is

seen as a significant driver of interest in SCF, because corporates as well as their

financial institutions are seeking to free up cash flow in supply chains while reducing

risks. Undoubtedly, the SCF program has the competence to develop the flows of

financial resources in supply chain management.

1.2.2 Research questionsIn this paper, two main research problems are expected to be answered:

Does the use of the SCF program in supply chain management have a positive

impact on short-term corporate performance in the time period of financial

crisis?

How come the contribution of SCF programs can help companies improve

profitability as well as control supply-side risks?

To answer these questions, studies on supply chain management in connections to

financial flows and supplier/buyer relationships are required as fundamental knowledge.

The deep understanding of integrating SCF into SCM has a decisive role. Furthermore,

the link between performance indicators and financial ratios based on the EVA model


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provides a framework for cause-effect relationships. The strategic financial solutions

provided by the SCF program can help build up a successful buyer-supplier partnership

in terms of pricing, payment terms and controlling supplier risks.

Several sub-questions are required to be studied regarding the main research problems:

1) What is the SCF program, and how to integrate SCF into SCM?

2) What are the performance and financial indicators on the program and how to

derive the indicators?

3) Could the application of the SCF program have the impact on short-term

corporate performance?

4) What are the relationships between financial supply chain management (FSCM)

performance indicators and profitability?

5) What is the practical application of the SCF program in the supply-side value

chain management?

6) How could large participants use the SCF program to cooperate with small

participants?

7) What are the expected outcomes by the application of the SCF program?

8) What are the most significant benefits and achievements for business partners on

the SCF program?

The use of SCF program is new in the international business; therefore there are no

standard procedures to measure the effects of corporate development with SCF. In this

study, it starts with embracing this financial solution into supply chain management and

derives important FSCM performance indicators and profitability ratios, in order to

measure possible outcomes. The FSCM performance indicators are obtained by

investigating the value drivers in accordance to supply chain business processes; the

profitability ratios are derived by investigating the financial ratios corresponding to

profit growth. The selection of the indicators and the ratios is based on the EVA model.

The expectations on observing the impact of SCF on short-term corporate performance

are settled, corresponding to the findings by Wang (2010). The time of perceiving

effects of development is critical, because every financial and operational solution takes

time to implement, sometimes mid-term and sometimes long-term. See the elicited

paragraph from Novozymes annual report. It takes Novozyme 2-3 years to observe theeffects of development on the supply chain finance.


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Cooperati on wi th Suppli ers

The target for 2007 was to develop a step-by-step procedure for how and when to further developcooperation with suppliers on issues of sustainability. In line with this target, we developed a new method

in 2007 for responsible purchasing that considers the risks and opportunities in our supply chain. Our

target for 2008 is to carry out a pilot test of this new responsible purchasing model in all regions with the

aim of implementing it in 2009.

Novozymes annual report (2007)

The contribution of this research is about to help business partners seek a superior

financial solution for solving supply chain cash flow issues in the crisis (See section

1.2.1). The financial crisis in 2008 is not so far away from now, so the mid-term effects

are difficult to detect at this moment. Additionally, some companies may adapt to the

program after 2008. Furthermore, in Wangs paper two-year time interval outcomes are

not different from the findings for one-year time interval. Therefore, the assumption ofthe short-term positive impact of SCF is logical. If this is true even around the financial

crisis, then the expectation of using the SCF program is more realistic. The immediate

positive outcomes are able to show that the SCF program is efficient to help the

business partners live on from the transitory overwhelming turmoil.

The EVA model is also used to build up the cause and effect relationships between the

FSCM performance indicators and profitability. The exact correlations between them

are expected to be explored by further empirical analysis. Concurrently, the significant

FSCM performance indicators in terms of explaining the effects on profitability are

drawn by statistical tests. Case study of SCF at Siemens provides the practical

application of the program. Discussions at this stage embody further understandings of

theoretical findings and modified explanations of empirical results. In the meanwhile,

the achievements on supplier-buyer partnerships with SCF are argued from different

points of views.

The predicted benefits acquired with SCF for large participants are essential. It gives

possibilities for using SCF to assist on the development of the value chain as a whole.

It will lead to win-win outcomes to all the participants in supply chains. The large

participants will support credit enhancement techniques to the small participants

reducing default risks, which can cause supply chain shortfalls. The small participants

can get lower cost of capital financing and speed up cash flows. The improved payment

term negotiation as well as standardization of payable process can help consolidate

long-term successful cooperating partnerships.


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Applying the SCF program is not only to achieve superior competences but also

enhance the synchronized level between operational business processes and financial

flows in supply chains. It is orientated to develop advanced inter-organizational

collaboration and communication, meanwhile the competition of the value chain as a

whole is more severe than individuals in the economic recession.

1.3Research methodologySeen in last section, the research questions are outlined regarding the impact of SCF on

corporate performance by supply-side value chain efficiency; the outcomes are able to

be observed in short term. In this section, a sophisticated research process is designed in

order to accomplish the research of interests. Research hypotheses, testing tools andanalytical methods are introduced accordingly.

1.3.1 The research processThe general research process of this study is shown in figure 2.It starts with defining

research problems relative to previous research findings and theoretical framework for

the SCF program. The inter-reactions at stage one contribute the formation ofhypothesis tests and empirical analysis at stage two. The intention of stage three is to

figure out the practical application and relate to previous findings as a result of

feedbacks. Because there are no standard research procedures conducted so far for the

SCF program, the combination of theoretical, empirical and practical researches are

comprehensive to summarize the outcomes.

The theoretical background is used to identify the FSCM performance indicators and

the profitability ratios which will be used in the empirical analysis. The interpretation of

the analytical results is used to confirm the significance of the selected indicators and

ratios. Sometimes the analytical results do not provide the expected solutions, if so, then

further discussions on the application of SCF will also rely on the practical application.

All in all, the final conclusions of this research are determined based on various findings

and arguments.

The research methodology is designed in accordance to both qualitative and quantitative

methods (Kothari 2011). Quantitative research is conducted by analyzing a random


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collected sample, in which certain research hypotheses will be tested. Qualitative

research is conducted by case study at Siemens with interviews and Q&A. Designed

qualitative research questions are outlined.

The data are randomly collected from public resources (Hendricks and Singhal 2005).

The events of signing the SCF program in companies are searched through the public

resources by key words, such as supply chain finance, trade finance, agreement. The full

text of articles should contain combinations of these keywords. Announcements from

the websites of SCF financial institutions are options too. The data will be sorted by

differentiating the key figures of the year after and before the event. The final dataset

contains different variables in columns that used to present the selected indicators and

ratios, and the companies in rows. The data analysis will be done by IBM SPSS

Statistics version 19 and R-2.14 programming.

The case study of SCF at Siemens depends on interviews and follow-up questions. The

introduction of SCF at Siemens and the implementation of SCF to its suppliers are used

as case references. Further communications regarding the qualitative research questions

are required. The summary of qualitative research experience is about to provide

sufficient practical conclusions besides the theories and the empirical results (Assadej et

al. 2010).

Financial accounting data is applied for both quantitative and qualitative research

methods, because the impact of supply chain financial solutions on corporate

performance is expected to be observed from the companys financial statement. The

SCF program is used as financial solution to enhance supply chain efficiency, and the

record of supply chain business processes are often related to operational figures.

Furthermore, the focus of the study is to explore the impact of SCF on short-termcorporate performance from both operations and financial flows. It explicates the

processing procedures in organizations. It is more robust than studying the impact as an

event on stock markets only, which cannot imply the effects of development on

operational performance (Hendricks and Singhal 2005).

The financial account data contain the information of corporate financial structure such

as cost of debt, which is related to annual interest rate of corporate loans not the

dynamic changes in stock markets (Berk and DeMarzo 2007). To improve the cost of


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money is a significant contribution by the SCF program because of cash flow efficiency

in supply chains (Camerinelli 2009). The financial accounting data might be useful to

analyze the events that reveal the corporate performance (Tomaso et al.2010), and the

measurement based on accounting may apply only within the context of a specific

predictive purpose or prediction model(William et al. 1968).

Figure 2: The flowchart of research process with detailed tasks at each stage

Sources: Authors design

I II III

Clarifying research focuses interms of research of interests and

research problems.

Understanding performance

indicators and profitability ratios,

the EVA model, the SCF, SCM, and

the benefits of applying the SCF

program.

Designing a research process with

statistical methods and qualitative

research methods. The framework

of empirical study is about to

derive cause-effect relationships

between FSCM performance

indicators and profitability. The

case study at the company is about

to modify the usefulness of

applying the SCF program.

Linking possible outcomes to the

research roblems.

Define

Research

Problems

Review

Concepts

and

theories

Review

Previous

Research

Findings

Formulate

Hypothesis

Collect, Analyze

and Interpret

Data

Formulating research hypothesesaccording to literature reviews in

terms of the research framework.

Conducting an empirical analysis

with the quantitative research

method, alongside descriptive

statistics, t test, correlation tests,

and regression analysis.

Reporting analytical results which

should give evidences to pursue

research of interests and answer

part of research problems, if not,

preparing further reasonable

statements.

Summarizing useful results for

further application.

Applications

and Practices

Feedback

Preparing a qualitativeresearch to explore the use of

the SCF program in practices

in relations to theory and

analysis.

Applying significant outcomes

from both qualitative and

quantitative research to

outline the most significant

indicators for improving

corporate performance.

Referring to the research

problems with the solutions of

applications and practices in

order to verify the quality of

the study and the contribution

of the research.


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1.3.2 Hypothesis, testing methods and research questionsReferred to the main research questions and sub-questions, the purpose of this study is

about to figure out the positive effects of using the SCF program on the corporate

performance. The verifications of selected FSCM performance indicators andprofitability ratios, and their relationships are required. Seen in Demica paper (2011),

the program has been well known since the financial crisis, so the year as a

representative of increasing popularity is also important. In general, there are four

research hypotheses will be tested on the subject of quantitative research method:

: The application of the SCF program has a positive impact on short-term corporate

performance in economic recession.

: The FSCM performance indicators and profitability are correlated.

: There are cause-effect relationships between the FSCM performance indicators and

the profitability ratios.

: The popularity of applying the SCF program is increasing.

Descriptive statistics will be used to observe the basic shapes of all the selected

variables. Following, to detect the sample outliers by Boxplot (John Tukey 1977) is

fundamental. The existence of outliers can distort linear estimators. The first hypothesis

can be tested by one-sample t test (Aczel 2006), which is used to discover the

significant impact of SCF based on the selected variables. The correlation tests with

Pearson, Kendallstau_b and Spearmans rhoare applied for testing the second

hypothesis. The significant correlated relations are used to give the evidence of

conducting linear regressions. The third hypothesis will be done by regression analysis

in order to establish structured linear models for profitability. The cause-effect

relationships are implied in cross-section estimation. The forth hypothesis is involved in

the regression analysis.

Case study of SCF at Siemens is done by qualitative research method. The endowment

of qualitative research experience is vital to modify the analytical results in empirical

studies. Four subsequent qualitative research questions are necessary:

3 Are the selected FSCM performance indicators and profitability able to present the

impact of the SCF program in practices?

4 How could the SCF program benefit large participants?


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5 Can the application of the SCF program help small participants lower cost of

financing and speed up cash flows and in turn control supplier risks?

6 Is the win-win outcome true?

All the practical questions are argued with respects to the theoretical and empirical

findings. Together with a basic evaluation of the selected variables by Siemens

accounting figures, the most significant FSCM performance indicators and profitability

are able to be prioritized. The improvement of supply-side cooperation is studied by the

methods applied at Siemens. At the end, the benefits for Siemens and its suppliers on

the SCF program are highlighted.

Qualitative data are gathered primarily in the form of spoken or written language ratherthan numbers. The data resources are from the interview and follow-up Q&A with the

coordinator at Siemens. The interview focuses on the introduction and implementation

of SCF at Siemens. The data from the interview will be transformed into written text for

further analysis; the subsequent Q&A will be done by emails. The interpretation of

qualitative data is not very complicated, and it is done by the self- reported technique.

1.4DelimitationThere are limitations to conduct the research of the SCF program on the corporate

performance:

1 The study concentrates on companies instead of banks or financial service providers.

The banks or financial service providers are responsible for the development of the

SCF program in international business. From the companies points of view,

applications of the SCF program and its contributions to the supply-side partnershipimprovement are fundamental.

2 The time period around financial crisis is very special, and the SCF program is just

one factor that can help companies to recover from the economic recession. The

influences of the program on corporate performance could be partial, even though the

expected outcomes specified by literatures are optimistic.

3 Negative cash flow cycle technique is not covered in this research. The application of

the SCF program is to optimize the capital utilization, but not to use customers and

suppliers as sources to have interest-free cash financing in business processes.


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4 The announcements of supply chain finance are not easy to be found by public

resources, so missing data in the random sample collection is unavoidable. Some

announcements are lack of event year, so they cannot be used. By contrast, some

companies may not announce the events in the public, although they have already

applied it as a financial solution in supply chain management.

5 The dominant power in supply chains can be revealed by either suppliers or buyers.

It depends on their company sizes. Usually larger/stronger participants on the SCF

program are somehow prevailing to affect supply chain solutions.

1.5Thesis outlineThe thesis outlines in six chapters. Chapter 1 is the introduction containing research

settings; the problem formulation and the research procedure provide a guideline which

is related to the follow-ups in coming chapters. Literature reviews are in chapter 2; main

theoretical and empirical references are discussed here. Theoretical study of the SCF

program in Financial-SCM is in chapter 3; FSCM performance indicators, profibatility

ratios and their cause-effect relationships are derived based on the EVA model.

Empirical analysis of the selected indicators and ratios is in chapter 4; the impact of

SCF on short-term corporate performance and the effects of development on

profitability are interpreted based the analytical results. Practical application of SCF is

in chapter 5; the case study of SCF at Siemens provides in-depth understandings of the

selected indicators and ratios, and the win-win outcomes of using the SCF program.

Conclusions are in chapter 6; criticism and suggestions for future research of interests

are stated.

Chapter 2 Literature review

In this chapter a framework of supply chain finance and its integration to supply chain

management will be introduced first. The impact of financial crisis brings new

challenges as well as new opportunities to the development of supply chains. The link

between supply chain and financial flows is considered as an inevitable strategic

solution while improving corporate performance. The introduction of supply chain

finance to the supply chain management is able to help corporates remain competitive


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and increase economic value added. Ideally, the effects of development are possible to

be observed in short term. Ultimately, the win-win outcomes will benefit both large and

small participants.

2.1 The development of supply chains

Nowadays the supply chains have been developed more complicated as the business has

become more international. The term of supply chain management is first introduced by

U.S. industry consultants in the early 1980s (Oliver 1982). The expansion of physical

capabilities in international logistics has started since the early 1990s, and the trend of

global economic integration becomes evident everywhere. With the development of e-

business, communications between suppliers and buyers become instant by information

systems. For example, the buyers can have access to any suppliers irrespective of

location and available at any time. It reduces costs, improves service levels and

increases profits. The improved communications through new technology are the

enablers of supply chain integration.

The popularity of international integration brings the new challenges to the management

of multiple relations in the supply chain. This also leads to a broad inclusive view oflogistics, which is not only responsible for one to one business, but a network of

multiple businesses and relationships. It is extended to combine all related activities into

a single integrated function Waters (2007).

There are many researchers have studied on various processes of in supply chains.

Lambert and Cooper (2000) point out that a successful SCM requires a cross-functional

integration in the firm by coordinating activities of the key business processes. The

links of business processes have direct effects on the levels of decision making, such as

operations and financial planning, supplier risk and customer services management.

Thus, analyzing and designing an efficient and effective supply chain have gained an

increasing attention, and models of evaluating supply chain performance are diverse as

investigated by Beamon (1998). He implies that a traditional supply chain is

characterized by a forward flow a materials and a backward flow of information and

finance.


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Farris and Hutchison (2002) have emphasized the cash-to-cash cycle concept to the

supply chain management perspectives. It contains three important leverages which are

account payables, account receivables and inventory. In the meanwhile, the idea of cash

management has also been sentient in supply chain business processes.

Badell (2005) addresses that the financial flow optimization in operation processes will

satisfy shareholders as well as improve supply chain efficiencies. Cash flows are

involved in each supply chain business process and the optimization of the financial

flows is required at each stage. It shows the necessity of managing financial flows in the

supply chain business processes, and it is significant to implement the financial-SCM

strategic plan. It heightens the decision-making capacity of the CEO and the CFO in

complex scenarios.

The cash inflows and cash outflows in supply chains are strongly dictated to the capital

capacities in companies. The synchronized level between supply chain management and

the financial flows can be seen as indicator to measure the operational efficiency and as

a result the financial liquidity in the companies.

2.2 The link between supply chain and financial flows

There are many companies have not noticed the disconnection between overall business

strategy and supply chain strategy in the organization; financial, information and

physical flows are seldom synchronized. However, economic growth and capital

utilization in the firm are expected to be optimized through the integration of

information, financial and physical supply chains. The strong interdependency between

operations and financial departments enables corporate to maintain competitive

advantages in industries.

Seen studies on financial flows in the supply chain, certain part of researchers are

orientated to have applied cost models on the basis of accounting theory, such as

Activity-based costing (ABC) that was introduced by Kaplan and Cooper (1988a,b).

This has been broadly applied in multi-level, manufacturing organizations. In the 1990s

many companies move their concentrations on competitions to reduce their own costs as

well as those of related partners in supply chains. The competitions among companies

rely on a more cost-effective chaina lower cost to serve the final marketplace and


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achieved in the shortest time period possible. The ABC tools are not used for the

evaluation of financial performance, because delayed payment, return on

investment/equity are not concerned as analytical indicators. Therefore, this evaluation

tool is not satisfactory enough to be applied at the tactical stage for the overall corporate

valuation (Ozbayrak 2004).

Balance scorecard (BSC) is also widely applied when conducting performance

measurement. Bhagwat and Sharma (2007) summarize some key performance

indicators related to day-to-day business operations from four perspectives: finance,

customer, internal business process, and learning and growth. Moreover he has

considered the total cash flow time as the key measure in connection to the financial

performance. However, the case-effect relationships of the key measures to performancedrivers are lacking. So the supply chain balance scorecard is not sufficient enough to

reveal whether the operation improvements have been translated in order to enhance

financial performance.

Financial performance in connection to supply chain activities are always seen as cost

reduction, market share growth and profit increase (Chien 2007). There are positive

relations between financial factors and the innovative supply chain practices: the

improved supply chain business processes can benefit organizations through better

financial performance; the increased corporation profit and market position are

accompanied by an increase of the overall corporate performance. The integration of

physical supply chain and financial management with the backward information flow

should be done as a one package procedure in corporate. The synchronization is

expected to be accomplished by the harmonization between strategic business processes

and financial decisions (Guillen 2006).

Weissenrieder (1998) has adapted the method of discounted free cash flow (DFCF) to

calculate profitability and monitor the economic value added in the company. The

analysis of profit or NPV determines implementations of certain projects. But using

DFCF method to assess the strategic supply chain decisions cannot maintain sustainable

competitive in case that the financial impact on different operational alternatives is not

assessed in advance (Lanez et al.2009).

Normally, conventional organizations choose internal financing resources to finance thesupply chain and the related business processes. Yet, retained earnings, depreciation,


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redistribution of capital from the balance sheet of a company do not have cash payments

associated. Accounting earnings can present the economic value added in the firm but

not the direct cash that are ready to be spent.

Many academic researchers have described the differences between financial chain and

physical chain in terms of inventory, process and cash management. Yet, the measures

on the cost of capital regarding the impact of SCM solutions have not been explicitly

considered2, because the financed assets as well as the cost of financing are not

normally concerned on the bases of supply chain activities.

As a consequence new tasks at the intersection of finance and logistics/SCM open new

business areas for banks as well as financial and logistics service providers (Hofmann,

2005). The new concept about the integration of financial, information and physical

flows brings supply chain managers new thoughts to concern the importance of the

financial side of business activities. In turn, it gives the new challenges to supply chain

executives of speaking the financial languages to communicate on board and in the

mean while to build up cross-functional competences. The new trend of inter-

organizational interactions and cross-functional relationships provides new

opportunities for the development of supply chain efficiency and financial performance.

2.3 Supply chain finance

Supply chain finance (SCF) is an approach that aims to improve the supply chain

efficiency. It is intended to improve payment terms, to reduce costs and to accelerate

cash flows. Overall, the well-gained credit rating to the small/weak participants from the

strong/large participants (Myers 2002) and the simplicity of payable processes (Hartley-

Urquhart 2000) will enhance the supplier-buyer partnerships.

Collaborations between the financial side and the operating side need an encompassing

approach. It should not be an isolated concept but rather as an aspect of a more

integrated system or program to map the gaps between SCM operating performance and

financial performance (Timme et al.2000).

2 The cost of capital reveals credit risks overall the company. From companys point of view, the cost of

capital, i.e. the weighted average cost of capital is an appropriate discount rate to use for cash flows withrisk.


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The physical supply chain uses analysis and planning tools to meet and predict future

demand as well as international logistics; the financial supply chain incorporates

external financial service providers to jointly create value through means of planning,

steering, and controlling the flows of financial resources. The SCF program aligns the

operational flows with the financial flows (Camerinelli 2009).

Pfohl and Gomm (2009) show the SCF program is profitable for both sides in

organizations. Supply chain finance can be seen as a financial alternative for supply

chain management to better operate a competitive project. The small participants

obviously can receive the financial profits in accordance to the difference between the

interests of refinancing from the larger participants. It can also help increase the

operational benefits by the external financing services. The participants who join theSCF program can have comparative supply chain advantages through the transparency

of information and the upgrade of payment terms.

2.4 The integration of SCF into SCM

Reducing the financing costs and optimizing cash flows in the supply chain can be seen

as the main functions of the SCF program. It is orientated to motivate supply chaindevelopment, risk adjustment and value creation through improved operational

performances with respect to the reconfiguration of financial resources (Gomm 2010).

The levers of the SCF program are volume, duration and cost of money.

Benchmark financial indicators using supply chain operations reference (SCOR) model

can help supply chain managers to visualize the link between operational performance

and the financial statement (Ceccarello el at 2002). The use of Du Pont Model can assist

managers to determine the overall impact of operation decisions with respect to cash

flows and asset utilization (Kremers 2010). However, none of them is robust enough to

cover the issues of capital costs. The use of economic value added (EVA) model in

supply chain performance measurement introduced by Lambert and Polen (2001)

captures how the firm drives value and profitability from operations inducing the cost of

capital. Introducing SCF into SCM based on the EVA model can bridge supplier-buyer

related procurement processes. For example, the improvement of cash conversion cycle

time and supply chain velocity can enhance the economic profit of a company and

additionally have the effect on cost of capital (Hofmann 2003).


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Nowadays, the supply chain management expands to a scope beyond the operational

level of management. The task of SCF is to save the capital cost by means of integrated

relationships of partners and advanced financing activities in supply chains. Applying

this financial aspect to finance the supply chain gives us a new knowledge on the level

of management - financial supply chain management (FSCM).

The financial supply chain management is a specific set of solutions and services to

expedite the flows of financial resources and information between trading partners

(Michael 2009). The development of e-invoicing - paper-free transferring process of

payment and the supplementary corporation with third-party financial institutions result

in a simplified integrating supply chain procedure.

Spoken of the impact of supply chain decisions on financial performance, we often

discuss the lack of cross-functional coordination (Carter et al.2005). Thus a more

comprehensive integrated system is a consequence. It is also necessary to use the

system exploring if the application of SCF can help corporates enhance the financial

performances.

Wang (2010) has conducted an empirical study on the impact of SCF on short-term

corporate performance. KPIs for both supply chains and financial flows are applied to

present corporate performances. He concludes the implementation of the SCF program

is mostly used to solve short-term cash flow issues and to reduce operating costs. In the

summary, inventory turnover, return on sales and return on equity have been increased

at certain significant levels. In addition, the reduced cost of goods sold can increase

profitability significantly. The selection of the analytical variables in Wangs paper

relies on experience, so it is a kind of empirical analysis on common corporate valuation

indicators and ratios by a consideration of SCF application.

The introduction of the SCF program contributes financial services to business

processes that relate to financial issues in supply chains. The collaborations are based

on committing to share the resources, capabilities, information and risks on a

contractual basis. Stronger/larger participants are orientated to concentrate on the

process optimization and visibility between trading partners; smaller/weaker

participants are expected to provide sufficient financial and operating information.


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Generally, the large participants who initiate the SCF program are intended to increase

the economic valued added through payment term extension, and the small participants

who join the SCF program are going to enhance the liquidity through financing costs

reduction. The improved corporate performance can be observed from profitability, cash

flows and credit ratings.

2.5 Financing suppliers in the supply chain

The impact of financial crisis exacerbates corporate insolvencies and bankruptcy risks.

It affects the progress on sourcing of products, services and capabilities, because of the

risks of supplier defaults. The higher supply chain vulnerability with this setting makes

supply chain risk management (SCRM) more difficult for many firms (Blome et al.

2011).

Companies are oriented to continue tightening credit conditions when doing businesses

with each other, thus the liquidity has become inadequate. Large corporations would

like to extend payment terms deliberately, in order to maintain competitive for their

supply chains. However, small corporations in the supply chains are unable to sustain

further lengthening of payment periods because of the risk of insolvencies together withlower credit rating3. Instead, a mutual beneficial process is needed because of the

growing intense between business partners.

Changing suppliers is risky but essential and beneficial for the supply chain under

certain circumstances. However, sometimes many supply chains rely on a set of

specialized suppliers who are not easy to be replaced, and in the meanwhile it takes long

time to build up the new mutual trust supplier-buyer relationships in a short time.

Therefore, financing the supply chain is the most effective time-saving strategy.

The perception of financing the supply chain has been lasting for decades in the

developed economics. Factoring as a financial solution has existed by the form that a

company sells its account receivables to a factor (a third party that can provide

financing services to the seller) to get the advanced cash to run the business. Normally,

it requires good credit information from the seller. But defaults of customers may cause

388% of UK firms and 55% of German companies have identified that key suppliers are unable to sustain

further lengthening of payment periods (Kerle 2010).


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insolvency problems, thus the seller may not have enough reserves to repay the factor,

which will pass the burden of default risks to the seller (Klapper 2005).

The SCF program (reverse factoring) plays an important role in the progress of

financing suppliers through the standardized payable processes. The saved financing

costs from the payment terms on the SCF program are really beneficial to improve cash

flow efficiency and subsequently improve supplier relations (Dyckman 2009). Reducing

costs of capital financing as well as controlling credit risks is the most significant

feature of the SCF program.

Additionally, the application of open account rather than letter of credit (LC) in

international trade condenses the transaction costs in terms of charge fees from banks

and increases the cash flow speed in terms of a simplified payment process. By the

means of letter of credit, a vendor/supplier has to prepare all the required documentation

and then claim the payment from the bank with certain LC costs. The economic crisis

brings pressures to both banks and corporates and in turn increases costs of transaction.

Through open account alongside the endowment of the SCF program, the

vendor/supplier can get paid earlier and foresee the account receivables to manage the

cash flows in advance without extra charge fees (Appendix A3).

Chapter 3 Financial supply chain management

In this chapter, the application of the SCF program in supply chain management

including payable processes will be exhibited. The selection of FSCM performance

indicators and profitability ratios will be discussed according to the EVA model.

Following, detailed arguments on how the changes of supply chain efficiency can have

impacts on profitability should be stated. Overall, the whole chapter is extended to

provide fundamental theoretical support for further empirical analysis on cause-effect

relationships between the FSCM performance indicators and the profitability ratios.


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3.1Financial-SCM and the link to economic value addedThe concept of financial supply chain management is derived from the introduction of

supply chain financing programs from the bank or the third-party financial institution

with new forms of payable processes and payment terms between business partners. Thesuperior financial services provided by large participants and external financial

providers assist on increasing supply chain efficiency as a whole as well as remaining

competitive. Mainly it reduces the complexity of payable processes through open

accounts and in the meanwhile let small participants take large participants credit

ratings to reduce costs of capital financing. Overall it improves short-term liquidity in

the value chain and consolidates long-term supplier-buyer relationships.

The introduction of the SCF program to supply chain management can be seen as part

of the design of financial flows in supply chains. As we know supply chain decisions

are usually close to operational management instead of financial management. However

the SCF program is a financial solution to develop the supply chain management, and in

return the improved supply chain efficiency will enhance financial performance. To

explore that, companies are ought to link operational drivers to top level financial

indicators. The EVA model in figure 3 is used to link the value drivers from the

operations to the financial performance. The EVA model tree leads to 1) the netoperating profit after taxes (NOPAT), and 2) the cost of capital.

Figur e 3: EVA value-driver hierarchy and levers of SCF

Sources: Gomm (2010), Supply chain finance: applying finance theory to supply chain management to

enhance finance in supply chains.


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The EVA model seen in figure 3 provides the linking path that takes us from the high-

level financial performance towards more specific operational tasks. The EVA model

considers the value after subtracting the cost of capital. The capital cost rate is usually

defined as the weighted average cost of capital (WACC) which is the minimal required

return on the company sustained by both investors and creditors. NOPAT and other

corresponding operational and financial indicators will be discussed in the section of

FSCM performance indicators and profitability ratios.

3.2Integrating SCF into payable processes and cash flow cycleBy the impact of the financial crisis, the tied-up working capital has become crucial

because of the long cash flow cycle time from procurement to sales. Companies are

seeking an essential financing method to their own as well as trading partners. However,

the conflicted goals between buyers and suppliers increase the complexity to build up a

mutually beneficial process. The buyers wish to delay payment for their specific

financial situations and the suppliers want to accelerate collections.

The application of the SCF program in supply chains can create win-win outcomes for

the collaborating partners through simple and fast payable processes. Figure 4 showshow the payable processes work in supplier finance. As seen in figure 1, the buyer is

supposed to be the large participate and initiates the upgraded payable processes in the

financial supply chain management. Here, the same assumption of company sizes for

the buyer and the supplier is used.

Mainly figure 4 presents the internal financial and operational management through

ERP system in companies4. The agreement established between the buyer and the

financial institution contains legal issues, such as transparent data transforming in

processes5. In the meanwhile, the buyer has to provide detailed and timely financial and

operating information to the financial institution regarding the supplier.

4The ERP application is business management software and helps in centralizing all data and processesof an organization. It is mentioned here in order to assist on presenting how FSCM works in theorganization; however it is not the focus in this thesis.5The function of financial institution is very important in SCF processes; however the detailed argument

and research are left as future research of interests. The statement related to the financial institution in thisthesis is limited in how it can help the participants on the program establish a sufficient financial supplychain, indeed improve supply chain efficiency.


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Figur e 4: Account Payable fi nancing application in accordance with supplier fi nance

Sources:Authors drawing according to the Hartley-Urguhart (2000).

Overall it is important to consolidate the financial supply chain into a synchronized

system through high degree of information sharing and trust. Financial institution must

follow in all the payable and business processes, especially the receipt of goods. It is the

trigger for the financial institution to pursue future payment to the supplier. The payable

processes built up on the basis of SCF platform have simplified the upstream cash flows

in the supply chain between the buyer and the supplier. It liquidates also the tied-up

working capital in business processes. The supplier gets paid from the financial

institution before the maturity and the buyer pays to the financial institution regarding a

lengthened maturity.

Generally, the cash cycle time from procurement is defined as the elapsed time between

the payments of cash for materials up to the receivables for sales of the finished

products, seen in figure 5. The cash flow cycle time highlights how quickly a company

1. Buyer issues a purchasing

order to supplier

2. Supplier ships the goods

while transmits invoice data

Descriptions:

1) Buyer updates its ERP system to reflect the issuance and terms of the purchasingorder (PO) accordingly.

2) The invoice data should be matched with the PO data subsequent to the delivery.

When the shipment of goods is verified, again buyer updates its ERP system to

reflect the receipt of the goods.

3) Buyer vouchers the account payable (AP) in its ERP system and transfer payment

instructions to financial institution for future due payments.

4) Once buyer updates its ERP system to reflect the verification of AP, financial

institution is able to get the access to extract supplier profiles and calculate the

future payments for supplier based on buyers credit rating and publish them

before the due.

5) Supplier admits the early payment option to get cash inflow or receivables with

an attractive discount rate.

6) The financial institution sends a payment notice to buyer, and buyer confirms the

payment of full amount paid on the due date.

3. Buyer approves suppliers

invoice data and sends

payment instructions

4. Supplier is notified for

future payment through the

financial institution

6. Buyer remits the full

payment on the due which

settles the transaction

5. Supplier may convert the

future payment to cash

directly

Financial

Institution


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can convert its products into cash through sales. A rising trend of the cycle over time

specifies the company may be facing a cash flow crisis in the near future. So the cash

flow cycle is an indicator to specify the condition of working capital, and it is used to

detect non value-adding processing time in the supply chain (Hofmann 2003).

In figure 5, from the buyers point of view (blue dotted line) lengthening the days in

payables is rational to shorten the cash conversion cycle. From the suppliers point of

view (red dotted line) shortening the days in account receivables can help the company

lower the cash conversion cycle. The shorter the cash conversion cycle, the healthier a

company generally is, because less time capital is tied up into business processes.

Figur e 5: The operating cycle and its improvement by applying the SCF program

Sources: Authors drawing.

The improved financial-supply chain performance will lead to an efficient and effective

operating cycle with less time consuming (See figure 5). The improved operating cycle

can also help generate additional cash flows to pay off the liabilities on time. It provides

visibility to a higher quality of earnings, which enables the company to receive a better

Time

Order

Place

Delivery +

Invoice

Days in

Inventory

Sale +

Delivery +

Invoice

Days of Sales

Outstanding

Actual

Payment

Days in Payables

(time period to

payment of supplier)

Cash Payment Date

Days in Receivables

(customer payment time)

Expected Payment Date

Cash Conversion Cycle

Operating Cycle

Cash Flow Cycle


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corporate bond rating, indeed lower the cost of debt. It counts to the improvement of the

cost of capital rate i.e. the WACC (See figure 3).

Figure 4 and figure 5 have exhibited the application of the SCF program on the basis of

cash flow management in supply chains. There is an important outcome on the program.The supplier is possible to receive better offer for the cost of capital financing from the

buyer. See the EVA model in figure 3, from the suppliers point of view the lowered

cost of capital financing (cost of debt) and shortened cash conversion cycle will

indirectly decrease the cost of sales and directly reflect in the cost of capital. If we

discuss the savings orientated to the buyers opportunity costs, then it is possible for the

buyer to negotiate a better price offer in procurement which will also reduce the buyers

cost of sales. The win-win outcomes can be seen from both parties.

3.3FSCM performance indicators and profitability ratiosIn this section, operational and financial indicators regarding the SCF program will be

discussed broadly based on the EVA model. The selection of important FSCM

performance indicators depends on the features of SCF and the value drivers in supply

chains. Profitability ratios are chosen in accordance to the key figures that can present

growing profits in companies. The cause-effect relationships between the FSCM

performance indicators and the profitability ratios are derived by considering the overall

impact of supply chain improvements on corporate performance.

3.3.1 FSCM performance indicatorsKey performance indicators (KPIs) are also known as key success indicators. There are

various KPIs that are used for the measurement of financial supply chain management.

FSCM performance indicators will be defined from both supply chain operations and

financial flows (See section 3.1). Some of the KPIs are determined according to supply

chain solutions; some of the KPIs are derived with respects to financial-SCM

connection.

Timme et al.(2000) summarize that supply chain solutions can relate to annual revenue

growth, profitability and capital utilization. They specify profitability as the percentageof profits after subtracting from revenue total operating expenses. Cost of goods sold


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(COGS) as the percentage of revenue and selling, general and administration (SG&A)

as the percentage of revenue are defined as the operational value drivers to improve the

financial performance.

Capital utilization is the area with the greatest potential for SCM solutions to improve

the overall financial performance. The optimization of inventory, account receivables

and account payables are the main elements to be considered regarding the features of

SCF. Cash conversion cycle seems having the character to build up the connections for

these elements (Farris and Hutchison 2002), and it is also one of the value drivers of

SCM to improve the financial performance in the EVA model (See figure 3).

The long cash conversion cycle requires large working capital in operations, thus to

keep this value as low as possible is what the SCF program is ought to contribute

(Hofmann 2003). The cash conversion cycle covers the whole period from the cash

outflow of paying for production and cash inflow of selling products to customers, seen

in figure 5. There are three import components in the process: 1) Days Inventory

Outstanding (DIO), 2) Days Sales Outstanding (DSO), and 3) Days Payable

Outstanding (DPO)6.

Where:

thus we have

The CCC metric covers the value drivers from both supply chain and financial flows.

We can see that shortening the days in inventory, reducing days in average receivables,

and extending days in average payables can result in the decrease of working capital

requirement in operations. Cost of goods sold is used as a denominator to obtain DIO

6Jim Mueller: Understanding the Cash Conversion Cycle, Investopedia, May 16, 2010.


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and DPO, because DIO and DPO are the values related to supplier relationships. DSO is

paired with revenue, because customer relationships generate sales/revenue.

Inventory is also a value driver to influence the financial performance (See figure 3).

Inventory value (IV) is usually recorded as cost, because it is what the company has paid for

not sold. Besides the inventory value, inventory turnover (IT) gives more meaning to

specify the efficiency of SCM solutions. IT indicates the frequency of replacing or clearing

inventories in a company over a period. The higher this ratio is, the better the company uses

of inventory and the shorter the time between sales and cash collections.

The way of using average value is about to achieve a more conservative estimate during the

period of cash cycle (Simchi-Levi et al.2002). Cost of goods sold is applied to derive

inventory turnover, because inventories are purchased from suppliers as part of goods for

production.

Till now CCC, IT, CR (COGS% of Revenue) and SR (SG&A% of Revenue) are

summarized as main performance indicators for measuring financial supply chain

management. Based on the EVA model, they are ought to have impacts on the corporate

financial performance. The indicators are selected corresponding to the value drives in

figure 3. However some value drives are excluded, for they are not related to the study

focus and the features of the SCF program (See section 1.1). Later in this chapter, the

relationships between the selected FSCM performance indicators and profitability ratios

will be argued on the basis of the EVA model as well.

3.3.2 Key profitability ratiosFirst of all, let us see how operating processes and financial structure can be integrated

based on the EVA model. The net operating profit after taxes (NOPAT) and invested capital

are seen as independent of the companys financial structure and non-operating assets. It is

a kind of component that purely symbolizes the impact of operations on financial figures. It

can be used to calculate the return on invested capital (ROIC) which assesses how well a

company is using its money to generate returns (Koller et al., 2005).


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If we expand the equation into details including considerations of profitability

maximization, capital efficiency optimization, and tax minimization, then we have

where , is equal to revenue less

operating expenses (e.g. COGS, SG&A, depreciation). All the profits included in

NOPAT are available to both debt and equity holders. ROIC is a financial indicator, but

it solely focuses on a companys operational drivers, over which the manager has

control.

The ROIC tree in figure 6 expands the derivation into different operational components.

All the operational value drivers are exhibited on the right side of the tree. Operating

margin is equal to the gross margin (GM) less SR and depreciation/revenues. Further

down, the average capital turns is equal to operating working capital/revenues less fixed

assets/revenues.

Figur e 6: The tree of r eturn on i nvested capital (ROIC)

Sources:Koller et al. (2005), Valuation: Measuring and Managing the Value of Companies.

Gross margin

Pre-tax

ROIC

Cash tax

rate

ROIC

Operating

margin

Average

capital

turns

SG&A /

revenues

Depreciation/

revenues

Operating

working

capital/

revenues

Fixed assets/

revenues

S.1

S.2

S.3

S.4

S.5

S.1-S.2-S.3

1/(S.4+S.5)


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The operating working capital is achieved by subtracting current liabilities from current

assets7. It is a broad concept to show short-term liquidity in the company. Referred to

the arguments in section 3.2, the cash conversion cycle is involved in cash flow cycle

(See figure 5), which can be used to specify the condition of working capital in the

value chain (Hofmann 2003). Cash-to-cash cycle, inventory and processing time are

used to specify the working capital conditions on the SCF program (See figure 3) and

all these value drivers are used to derive the cash conversion cycle (See section 3.3.1).

Gross margin is obtained by deducing COGS from revenue. GM implies operational

gains by the impact of financial-SCM solutions, and its positive relation to the financial

performance is expected. The SCF program helps the company improve supply chain

efficiency from financial point of view, thus elements that can be influenced by SCFwill be prioritized. Here, depreciation and fixed assets are not explored for further

analysis, because they are accounting figures in accordance to asset consumptions in the

company.

The other part of the EVA model includes a companys financial structure. The capital

cost rate is usually represented by WACC, which is the companys opportunity costs of

funds and embodies a combined required return from both operations and financial

markets. The value of a company is driven by ROIC, WACC, and growth (Koller et al.

2005).

If we write the cost of capital in connection to the EVA model as follows:

and the EVA in figure 3 could be obtained by subtracting the cost of capital from

NOPAT,

so we have

A strong ROIC indicates high growth. When ROIC is greater than WACC, the company

creates value to both stakeholders and shareholders, and when ROIC is less than

7Koller et al. (2005).


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WACC, the value will be destroyed. The simplest form of WACC is the market-based

weighted average of the after-tax cost of debt and cost of equity8.

D/V = Target level of debt to enterprise value using market-based values

E/V = Target level of equity to enterprise value using market-based values

= Cost of debt

= Cost of equity

= Companys marginal income tax rate

Mainly WACC contains the market-based values; however the accounting figures are

used to study the impact of SCF as a financial-SCM solution on the corporate

performance. It is irrational to merge accounting data and financial market data together

conducting empirical analysis, because the financial market data is more dynamic than

the accounting data to reflect on the company events (See section 1.3.1). The

inefficiency in the analysis will generate biased solutions. Fortunately, the cost of debt

has relations to the cash flows of business processes (See section 3.2). So, further

improvement of WACC will rely on the studies of the cost of debt.

Other financial ratios that represent the growing profits are outlined as return on equity

(ROE), return on sales (ROS) and return on assets (ROA)9:

Return on sales is related to the determination of NOPAT in the EVA model. Although

the associations between ROS and supplier finance are not apparent, the net income as

the numerator to obtain this ratio explains the significance of reducing SG&A and

COGS by the use of the SCF program (See section 3.3.1).

8See Koller et al.(2005), chapter 7.

9See Chen and Shimerda (1981) and Wang (2010).


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Return on assets gives both stakeholders and shareholders an idea on how efficiently the

company is earning more money on less investment in operations. The increase of ROA

indicates that the company can convert the liabilities it has to invest into net income

proficiently. In a sense, we may expect companies who are with SCF can amplify the

utilization of liabilities by the improvement of payable processes and payment terms.

Return on equity measures how a company can generate profits by shareholders

investments. It shows the hard fact that if there are enough profits to compensate the

risk of being in the business or not. It reveals also the shareholder value in the company.

Talking about shareholder value and supply chain solutions together, the design of the

flow of financial resources in supply chains can affect return on equity (Hofmann 2003).

3.4The impact of FSCM on corporate performanceThe endowment of SCF in supply chain management brings benefits for both suppliers

and buyers, including the less time consuming operating cycle and the improved cost of

capital financing. The EVA model has been used as theoretical references to derive

FSCM performance indicators and probability ratios. It covers both operational and

financial performances in corporate valuation. Supply chain value drivers such as ITand CCC, operational value drivers such as CR, SR and GM, and profitability ratios

s

the impact of supply chain finance on corporate performance improving supply chain efficiency and...

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