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Calculum Inc

Let the market decide

October 13, 2022
Read time:
12 min

Calculum Inc

Press kit

March 5, 2020
Read time:
1 min

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End of December 2021, The Financial Accounting Standards Board (FASB) issued updates on accounting standards with the intent to create more transparency on the effect of Supply Chain Finance (SCF), also commonly known as reverse factoring, payables finance, or supplier financing arrangements.

The new requirements beginning to go into effect in 2023 require buying organizations using such financing programs to disclose sufficient information about the program. These disclosures include the key terms of the program, as well as the outstanding the buyer has with his suppliers and where that amount is presented in the balance sheet at the end of the reporting period.

As the recent FASB directives are being absorbed by the market it actually begs a broader question for corporate treasury and procurement as to how payment terms are set and determined from the perspective of treating working capital as a financial asset.

We should first look at the sophistication of capital markets when valuing and marking assets to market as the guiding principle. As a second step, we can follow the disciplined guidelines to adhere to best practices that companies employ rather than reliance on increased disclosure as the only way to bring clarity to financial supply chain solutions such as SCF. In closing, we look at the broader corporate question of establishing a payment terms strategy in general.

Mark to market

Mark-to-market is an accounting practice that involves adjusting the value of an asset to reflect its value as determined by current market conditions. In securities trading, mark-to-market involves recording the price or value of a security, portfolio, or account to reflect the current market value rather than book value.

Isn’t working capital an asset? A very valuable asset, kinda like the lifeblood of a business…. that kind of valuable asset?

Why is working capital not then marked to market with the same sense of practicality and fervent discipline as are other assets classes?

There are three primary levers that can be used in order to manage the efficiency and effectiveness of the working capital:

  • Inventory
  • Receivables
  • Payables

Inventory management is critical with companies relying on purchasing inventory and managing sufficient levels of goods in their ware house. Inventory has emerged as a key sticking point in the operating cash cycle of a business. Applying long inventory levels with inventory purchases strategically timed so that the materials arrive no earlier than necessary is critical and can achieve improvements in working capital. It is fair to say in the current supply chain backdrop that managing inventory availability is the main matter at hand.

Receivables are the easiest level to understand from the perspective of accelerating cash either by rigorous management of your receivables book or collecting outstanding payments. Easy in good times but watch the client's excuses blossom in hard times…”yeah the cheques in the mail - I swear.” Another common way to reduce a company’s receivables level if the credit risk supports is via discounting the receivables and getting paid earlier with a willing financier.

Payables are the lever with much more sensitivity attached to it compared to receivables discounting. Optimizing Payables and payment terms to suppliers can free up significant working capital but it can also do irreparable damage to the supply chain should it be yanked too hard or indiscriminately without due process and analysis undertaken.

Isn’t working capital an asset? A very valuable asset, as in kinda like the lifeblood of a business….that kind of valuable asset?

And so back to the idea of marking to market your working capital. The key is to use an objective, universal data signal to review and benchmark working capital efficiency and performance. This data point is payment terms applied and used by trading partners. The advantages of incorporating market-derived data signals when setting and applying payment terms carry such weight it is somewhat surprising it has yet to catch on in procurement and treasury.

Coming back to the FASB disclosure guidelines, at what point are payment terms for a company’s payables stretched well beyond industry norms, and what is considered a fair and reasonable payment term in the pharma-industry versus the retail or mining sector? Buying organizations are asking themselves am I the outlier with excessive payment terms or am I languishing in the 1st quartile in my industry? Where is my bearing point? Can one subset of suppliers bear longer payment terms as opposed to others and why?

What impact will sustainability and ESG (Environmental and Social Governance) initiatives have on my working capital and on my suppliers’ working capital?

Ultimately, the answer can only ever be thus; what is the market signal, the prevailing market conditions, and the current best practice in the respective market? And how do you ingest, absorb and analyze the vast number of data signals that are required to give a Corporate a defensible payment terms policy?

I am certain of one thing for sure: The volume, velocity, and variety of data have also increased dramatically with the rise of big data. As a result, we’ve seen spreadsheets in board rooms with vast amounts of data, formulas, and hundreds of sheets. The question is whether spreadsheets were intended to act as some market analysis tool or perhaps a database would be better suited for such purposes.

Balance sheet disclosure as directed by the FASB is welcome however it does not solve the issue of what are acceptable payment terms in a given market. By default, ‘disclosure’ is past tense. Hence, it does not solve real-world challenges.

Before we reach for greater disclosure as the pole star in determining behavior and transparency in payment terms we should think about establishing a market-driven and data signaling infrastructure that provides the signposts and framework to establish acceptable payment terms and working capital efficiency for all participants.

Coming back to the FASB directives, transparent balance sheet disclosure is welcome however it does not solve the issue of what are acceptable payment terms in a given market, industry sector, commodity, or country. By default, ‘disclosure’ is past tense. Hence, it does not solve real-world challenges.

For example, take the forecasted demise in the just-in-time (JIT)inventory model due to the massive and ongoing supply chain disruptions. Today, many corporates are trying to determine the ratio of Just-in-Time (JIT) Inventory versus Just-in-Case (JIC) inventory in order to decide what is essential and those suppliers that are more discretionary to be better prepared for the next external disruption. In doing so, companies are looking to be better prepared so as to not be caught off-guard in the future due to a lack of raw materials or port shutdowns.

According to the IHL Group, a global research and advisory firm for the retail and hospitality industries,  the true cost of inventory distortion out of stocks and overstocks in the retail sector alone is expected to be over $1.9 trillion in 2022. At the core of this inventory, distortion is JIT and production location i na small handful of countries.

Nearly $1 trillion of the $1.9 trillion inventory distortion issue is the result of a just-in-time inventory system that relied too heavily on production in a small handful of countries.

If this is indeed accurate then we have a significant change ahead on how global supply chains will work and will be used as a competitive advantage in the coming years. Part of that change will be establishing parallel supply chains in a wider geographic footprint.

What is certain is that system change means capital investment, which means working capital. Working capital means optimizing inventory, receivables, and payables. And finally, reducing receivables and increasing payables, means optimizing and aligning payment terms to the market. It is circular and it requires real-time market-derived analytics as a must-have rather than a nice-to-have.

Moving forward, if the path to greater supply chain resiliency requires more countries in the sourcing mix including nearshoring/onshoring, and parallel redundancy in supply chains, then part of the great analysis reset must include what are current working capital models and payment terms across multiple jurisdictions, commodities, and sectors and how payment terms create maximum working capital efficiency for both the corporate buyer and its supply chain.

Only the market can approximate the truth of the current situation upon which to base a future direction. Spreadsheets and outdated payment terms trapped in contracts are not the paths through the current supply chain challenges when it comes to working capital conversations. The solution is a universal, global payment terms market allowing corporates and their trading partners to mark themselves to their individual markets in real-time and gain a competitive advantage.

One such example offering market data insights on payment terms is Miami-based Fintech company, Calculum. The company is deploying mark-to-market analytic capabilities for payment terms using the capital markets model as a guiding principle.  Treasurers and procurement leaders must own the agenda on payment terms from a market perspective rather than leave it in the hands of regulatory overseers in order to maintain flexibility and options when it comes to generating working capital for their business and their supply chains.

The solution to optimizing working capital whilst adhering to market-accepted boundaries and  market standards for any given industry or commodity is a dedicated and purpose-built database that is fed by the market and leverages AI to provide constantly updated data which provides insight to companies and their trading partners on what are the appropriate payment terms that reflect current market conditions.

The precedent already exists and has so for multiple decades. That precedent is the capital markets that on a daily basis provides clear, reliable signals on the price, availability, and direction of multiple assets.

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