What is a cynic? A man who knows the price of everything and the value of nothing- Oscar Wilde
Many people think suppliers value capital obtained through Supply Chain Finance based on their cost of debt. According to this logic, a supplier will participate in SCF only if the SCF rate is less than the supplier’s short term borrowing costs. On the surface this looks like it makes sense, since it seems that short term borrowing is the alternative to SCF funding. However looks can be deceiving. Digging a little deeper, SCF provides Free Cash Flow (operating cash flow minus capital expenditures), while borrowing provides financing cash flow. The two are not the same. Free Cash Flow (FCF) is clearly more valuable – it is the basis on which companies are valued. Most manufacturing and consumer goods companies use Free Cash Flow as a key objective. I don’t see many with increasing debt as a key objective. So how much more valuable is Free Cash Flow than financing cash flow? In other words, how much more valuable is SCF cash flow than borrowing? The value of Free Cash Flow is somewhere between the cost of debt on the low end and the cost of equity on the high end. I think we can narrow it down further than that to somewhere between the cost of debt and the weighted average cost of capital (WACC). Based on observed supplier behavior, the more material the spend is with the supplier, the closer they will value Free cash flow from SCF to their WACC. Another key factor in how suppliers value FCF is their corporate objectives. Suppliers with objectives around asset efficiency (eg. ROIC, Working Capital /Sales, FCF/Sales, etc.) will also value SCF cash flow closer to their WACC. Other supplier business drivers which impact how they value SCF include growth opportunities, capital intensity and ownership structure. One of the most important things we can do when educating suppliers about SCF is to make sure they understand that cash flow from SCF is Free Cash Flow, not financing cash flow, and that the two should not be valued the same.
Published April 18, 2013