Financing The Cash To Cash Cycle

Financing The Cash To Cash Cycle

–        Should adhere to the “matching principle”.  An efficient and effective supply chain can minimize the need for external financing and allow the cash flow from operations to fund a firm’s financial needs

–        Before turning to external financing, a business should get the most out of its supply chain by generating more cash from operations.  Executing on a firm’s supply chain strategy and overal corporate strategy is critical here, for the effectiveness of the strategy manifests itself in the corporate budgets and the meeting of those budgets

–        The timing of cash outflows with cash inflows is critical.  Optimally, one would try to match each dollar of outflow with each dollar of inflow.  There are so many external factors with controlling the supply chain that this may not be possible, hence the need for external financing.  A business needs to manage its C2C in order to avoid financing.

–        One of the main rules for determining a business need for financing is to remember to look and see if there is idle cash in the business.  If there is, a firm should invest any idle cash into short-term investments, continually making its money work.

–        A business should know and understand the term structure for interest rates.  By knowing the range for interest rates, then a business can know what interest rate it is willing to pay.  This can be huge because of the potential supply chain cost implications.

–        A business will plan it s needs based on a cash budget, which is based on the other business budgets that drive the business.  The cash budget must take into account estimated cash inflows, outflows, and capital expenditures.  Cash inflows consists mainly of the turning of receivables (better know as the order to cash cycle) and sales, and cash outflows from payables (known as the purchase to pay cycles)

–        Borrowing can come in different financial instruments such as loans, commercial paper, bonds, equity securities, and collateral financing.  Since this is a supply chain class and not a finance class, we will not focus on these short-term financial instruments.  Just know that the supply chain execution is the key to a firm being able to offer these type of securities to investors.  Most businesses finance the supply chain with short term secured or unsecured loans such a line of credit or term loans.  These loans lead the supply chain through periods of seasonality and cyclicality.  While the business waits for its cash flows (especially on a seasonal basis), the loans will allow a business to finance through the purchase to pay and order to cash periods.  A business sometimes will have a hard time generating enough operational cash flow, but also be too risky for a traditional financial institution to give financing.  A business will then resort to receiving financing based on the collateral of its receivables and inventory.

–        Some of the collateral based loans in this category are factoring, asset based loans, inventory loans, and supply chain finance.  Factoring is where a business will sell its receivables to a bank non-recourse (which means that the business gives up ownership of the receivable) and the bank will pay for the receivable at a discount.  The bank receives its funds back once the funds come due; the customer directly pays the bank.  Factoring allows the business to get its cash quicker and not have to wait for it, but it is a very expensive form of financing due to the discounted payment.  The ultimate cost of financing can be in the 30-40% range.  Asset-based lending is a special type of  financial arrangement where a bank or other financial institution will finance a firm’s A/R and inventory and allow the firm to keep possession of the receivables and inventory.  The firm will submit “loan base reports” to to allow the financial institution to monitor the quality of receivables and inventory.  Banks and other financial institutions place limits on the amount of inventory and receivables they will lend against.   Banks will also establish special checking accounts and lockbox arrangements to control the flow of cash to pay down the collateral secured loan as a firm collects it recivables and liquidates its inventory.  This arrangement is cheaper than factoring but expensive none the less.  An inventory loan is a short term loans to finance the purchase and/or manufacture of inventory.  This type of loan is the help the business finance inventory when it has inadequate working capital.  Supply Chain Finance (better known as “reverse factoring”) is where a bank will finance a buyer’s confirmed receivables with a supplier.  The bank uses this arrangement to finance high credit quality clients only because this arrangement amounts into an unsecured loan.  The supplier keeps the receivables and reports them to the bank, and the bank will pay the supplier the invoice amount.  The bank will also debit the buyer’s account for the amount.  This arrangement allows the supplier to get cheaper financing by allowing it to receive the finance rate of the buyer, thereby taking costs out of the supply chain.  These are the major forms of financing for the supply chain.  

–        As with any form of financing, the rate at which a business finances its operations is based on its credit risk, or ability to perform and pay back the loan.  It is for this reason that financing for business is not the same, and interest rates (financing costs) can differ across the board.  Good supply chain management will increase the likelihood that the business will perform and meet its obligations, there by being a lower credit risk and receivable a more favorable cost of financing.  This will in turn lower supply chain costs.


Businesses offer trade credit with other business, which is an important form of financing for working capital.  It is important that businesses reduce their costs by formulating policies to minimize the credit risk of other business and maximize its cash flow.


Before business offer trade credit it should conduct due diligence through a credit evaluation and scoring process.  The most scoring methodology is through a process known as the five C’s of credit.  They are:


  • •       Character – The customer’s willingness to pay to meet credit obligations.
  • •       Capacity – The customer’s ability to meet credit obligations out of operating cash flows.
  • •       Capital – The customer’s financial reserves.
  • •       Collateral – Asset pledged by the customer fro security in case of default.
  • •       Conditions – General economic conditions in the customers business


A firm should assign a rank of scores (say 1-10) for each of the five C’s, and establish a cutoff score to offer credit.


Once a firm offers credit, it must make an effort to monitor its A/R and administer a collection policy.  A firm must detect if a customer will not pay according to agreed upon terms.  One of the best ways to ensure minimum collection issues is to pick the right customers in the first place.  Along with the five C’s of credit, and business can receive payment information from such sources as Dun & Bradstreet, Lexis-Nexis, and the credit reporting agencies (Equifax, Experian, and TransUnion).  The business must enforce its collection policies fairly and appropriately.  A firm may discontinue credit if a customer does pay according to terms; this can cause conflict between the sales and collection departments.


In summary, good supply chain management will allow a firm to manage with C2C and working capital for more streamlined operations and reduction of supply chain costs.  In financing its supply chain operations, a firm must be aware of financing options and potential issues ahead of time in order to reduce financing costs and overall supply chain costs.