Supply Chain Management PDF

Supply Chain Management Part 1 The Cash to Cash Cycle The Cash to Cash Cycle is a key measurement to supply chain management. It is a measure of how fast a business takes its cash and converts its business process to cash again....

Supply Chain Management Part 1 The Cash to Cash Cycle The Cash to Cash Cycle is a key measurement to supply chain management. It is a measure of how fast a business takes its cash and converts its business process to cash again. In the finance world, this called working capital management. One may ask why finance is being used to talk about supply chain management. The reason is that financial statements give insights into the supply chain decisions of a firm, and how good those decisions were as compared to competitors. In essence, how efficient is one supply chain firm compared to the next, hence the term “supply chain versus supply chain”. The cash to cash is the major measure of the efficiency. “The connection between supply chain and a company’s financial performance has been at once both well-known but not so well understood. There was something of a watershed with the 2008-09 financial crisis, when companies in effect used the supply chain as a source of cash as traditional credit simply dried up. The next five years will see the field of supply chain finance continue to mature, and understanding how supply chain impacts the income statement, balance sheet, cash flow statement, and return on assets will become almost essential to reach upper level positions in supply chain. This will be an increasingly common area of internal supply chain training (as some do today). The position of VP of Supply Chain Finance, found in a few companies already, will become more common.” Any analysis of a firm’s supply chain and its impact to the cash to cash cycle has to begin with understanding the business model and the industry in which the firm operates. Questions to ask are:  What does the company do?  What industry does it operate in?  What are the competitive factors in its industry (the market, no. of competitors, its product lines, etc?)  What is its competitive advantage?  How does it satisfy its customers?  What value does it provide to the end user?  These are the major that not only define the firm, but also defines its strategy and ultimately the shape and structure of its supply chain. The financial statements of the firm are the “lens” of the business. They allow one to see the financial impacts of management decisions on the firms; they also give valuable insights on how well the supply chain functions and delivers value to its customers. The financial statements give the financial position of the firm at a point in time as well throughout a financial period. A firm’s balance sheet gives the point in time perspective of the business, and the income statement (or profit and loss statement as it is sometimes called) gives the period perspective of the business. Other financial statements which are important include the cash flow statement and statement of shareholder’s equity, which will be discussed in next week’s coverage. As stated earlier, the cash to cash cycle is an efficiency measure by which one can see how long it takes to bring cash into the business. The accounts affected by the cash to cash cycle include accounts receivable, inventory and accounts payable. The equation for the cash to cash cycles is:  Accounts Receivable (A/R) + Inventory (Inv) – Accounts Payable (A/P) = cash to cash cycle (also sometimes called the cash conversion cycle – CCC) An explanation of the cash to cash cycle A business will usually make a decision to purchase raw materials or services once it has made a decision to make product or provide a service. The old adage that it “takes money to make money” is paramount here. Let’s assume a business will make a product. The business will need an order from a customer; it will need to buy raw materials (which is account payables and inventory), formulate a manufacturing process to make the product, sell the product (which is an account receivable), and receive final compensation for the product (cash). While the business is making products, it is still incurring expenses such as payroll, buying inventory and equipment, operating a facility, and so on. These expenses consume cash. Preferably, a business would desire to collect its cash from its customers before its expenses were due. This does not happen very often in business, which then forces a business to incur more finance costs by borrowing on a credit card or line of credit until it receives its cash. This finance cost ultimately ends up into the final cost for a product or service. The longer the gap between a businesses’ spending its cash and collecting its cash, the more finance costs it will incur. How does the supply chain play a role in solving this problem? The supply chain plays a huge role in this cycle. For instance, what happens if products do not get made on time for customers? What happens if there is a bad forecast and too much inventory is made? What happens if one of a business’ key suppliers goes out of business? What happens if a key customer goes out of business? What happens if a manufacturing facility is damaged and cannot operate? All of these supply chain issues have an impact on the firm’s cash to cash cycle and ultimately its overall cash flow. Cash Flow is analogous to blood in the human body; just as a human being will die when loosing too much blood, a firm without an agile and nimble supply chain can suffer huge impacts on revenues and costs, which will cause it to lose a lot of cash (blood) and in turn make its insolvent (unable to meet its current obligations) and ultimately make it go out of business (die). As one can see, it is very important to manage the supply chain and its effects on the cash to cash cycle. If a firm does not manage its supply chain properly, it will ultimately go out of business. Delays in the supply chain affect the C2C cycle which affect the amount of working capital in the business and ultimately the financial health of the business. In order to understand how the supply chain affects the cash to cash cycle and the health of the business, one must take a look into how the supply chain affects A/R, A/P, and inventory. First, we must begin by understanding the concept called “working capital”. Basically, working capital is the amount of capital it takes to run the business. As we stated before, one tries to match cash flows with outgoing expenses; working capital is that amount of capital that makes up the gap it takes to run the business. The more efficient the cash flows are, the less working capital it takes to run the business. The accounting equation used to express working capital is Current Assets – Current Liabilities. Current assets (by order of liquidity) include cash, accounts receivable, inventory, and prepaid expenses. Basically, current assets are those assets which will be used by a business in one year or less. Current liabilities include accounts payable, short term expenses, short term debt and accrued expenses. Basically, current liabilities are those obligations of a business due within a year. The working capital equation basically says that a business should have has more assets that will turn into cash in one year that obligations that will come due within a year. Working capital should be positive, except in the case of the Dell Computer Model, where it receives its cash instantly and can take up to 90 days to pay suppliers. We call this “negative” working capital, but the term is good because cash is coming in at a much faster rate than cash going out of the business. Out first working capital equation is known as the “practical” method because it is easily identifiable on the balance sheet and easy to calculate. There is also a method called the “conceptual” method which uses the accounting equation and the practical working capital equation to discern how current assets are financed in the firm. Here is a breakdown of this equation: WC (The Conceptual Method) – Assets = Liabilities + O/E – Cur Assets + LT Assets = Cur Liab + LT Liab + O/E – Cur Assets – Cur Liab = LT Liab + O/E – LT Assets – WC is supported by Cur Liab and some portion of LT Debt and O/E As one can see, a firm supports its working capital needs (assets) through a combination of short-term debt, trade credit, as well as long-term liabilities and equity in the firm. Basically this can consist on how much debt the firm incurs, how much the firm earns through its operations, and how much equity capital a firm raises. The way an effective supply chain affects working capital is that when customer requirements are met, the firm will incur more business and increased sales. A firm who manages a lean supply chain cuts expenses, which creates more earnings and increases equity through increased retained earnings. An effective supply chain allows for better use conversion of A/R and inventory (current assets), which decreases the need for working capital and frees up cash to be used in other areas of the business. When cash is freed up, then there is less of a need for debt financing, which ultimately lowers supply chain costs. Managing the cash to cycle with an effective supply chain will improve the financial health of a firm through lower costs and improved financial liquidity, profitability, and solvency. Now that we can better understand the impact of the supply chain on the firm, it is important to observe what supply chain activities affect the cash to cash (C2C) cycle. We know that the C2C equation is A/R + Inv – AP, so it important to identify the activities which affects each of the cash to cash components. Supply chain activities which affect Inventory include: Slow moving inventory – While this topic could be the subject of an entire course, it is fairly obvious to say that slow moving products tie up cash. The problem here is that having the wrong inventory has huge implications for the business regarding revenues, costs, and survival of the business. Good inventory management, starting with the procurement process and ending with the distribution process, will free up cash and better satisfy customers. Sales Growth (up or down) – See statement in A/R section. Purchase and transport economies of scale – This relates to additional inventory being purchased that is lower in cost due to production efficiencies and/or lower transportation Cost due to using lower truckload rates. There is a trade-off between the lower costs and the amount of additional carrying costs which will incur due to storing the additional inventory. The cost savings due drive up the amount of inventory, which will increase the working capital requirement and lower the efficiency of the C2C. Manufacturing Efficiency Needs – This is related to purchase economies. As manufacturers make more units of inventory, they spread fixed costs over more units which lower overall unit costs. In addition, special orders discount the use of fixed costs altogether which lower unit costs. Additional units increase inventory carrying costs and working capital requirements, which lowers the C2C. Forecasting Errors – Pretty obvious here, a bad forecast will result in excess inventory or lack of inventory, which will tie up cash or result in lost sales. In either case, the C2C is negatively impacted. Lack of strategy alignment – Not knowing customers and their requirements results in the wrong products or services being rendered, which can result in too much inventory and obsolete inventory, which will negatively impact the C2C. Long Supply Chains – This results in more inventory in transit and more overall inventory, which affects cash and the C2C. Seasonality – See statement in A/R section. Cyclicality – See statement in A/R section. A firm’s competitive position – See statement in A/R section. Product Life Cycles – See statement in A/R section. Valuation Policy (FIFO, LIFO, Weighted Average) – The affect the value of inventory, which impacts the inventory cost calculation. This can be of get effect during inflationary times. During FIFO, inventory has less overall value as compared to LIFO when prices rise, and more value as compared to LIFO when prices fall. Inventory value affect the calculation of inventory turns and affect the C2C calculation. Supply chain activities which affect A/R include: Negotiated Payment Terms – Negotiated payment terms can lengthen or shorten the C2C. Payment term depend upon the perspective regarding cash flow for the business. Some businesses want delay payment and use the cash flow other areas; some businesses want to time cash outflows with cash receipts, and some businesses want to pay early to take advantage of discounts. Payments terms affect both large and small businesses, but delayed payments tend to hurt small businesses because they need to turn cash more readily fund the business. Small businesses may not have the cash balances or the necessary credit to fund the business while waiting on cash payments, so long payment terms can make it difficult for a small business in meeting its current obligations. Sales Growth (up or down) – When a business grows, it will need more inventory to support rising sales. Sales growth can strip a business of needed cash and increase costs because a business will to utilize credit facilities to buy the inventory needed. When a business declines, cash is still needed to cover expenses, pay for machinery and meet debt obligations. Good supply chain affords for better collaboration between businesses so that sales declines are better anticipated, and working capital needs are adjusted accordingly. Credit policies – Credit policies affect supply chain activities. Selecting good customers in the first place is a good way to keep revenues flowing and mitigate the risk of non- payment. Some business, in order to grow sales, will extend the payment terms of customers. This “extended” credit will spur customers to buy more products, at least in theory. Extended credit terms can hurt the C2C for a firm, and strip it of cash to run the business on a daily basis. This can hurt a supply chain relationship for a firm, especially when it can’t pay its suppliers within specified terms because it has extended terms with its customers. Slow Paying Customers – This relates to the credit policies section. Slow paying customers siphon cash from the business and increase working capital investment through non- payment. Again, these customers can be the most unprofitable form a supply chain standpoint. Seasonality – Some types of products or services only sell mainly during certain times of the year. Lawn services, homes, and toys are examples of these products and services. Because there is not enough manufacturing capacity to meet projected demand, inventory has to be built up and made ahead of time; or for a service, equipment and people remain idle during the offseason. This build-up of product or idleness ties up cash and creates increased working capital investment. Good supply chain management allows for better planning and alternative uses of resources to minimize inventory investment and better resource utilization, which decreases working capital investment and increases the C2C. Cyclicality – Business cycles change due to changes in the economy, global issues, and changes in consumer tastes, political risks and the like. This could cause changes in needed inventory and/or services. Good supply chain processes such as improved forecasting and better collaborative planning, allow businesses to better anticipate cycle changes, which allow businesses to reduce working capital investment as needed. A firm’s competitive position – A firm’s competitive position (and having the right supply chain strategy to match) is critical for a firm’s survival. A firm establishes it competitive position by supplying what the customer desires at the least cost. A firm’s competitive position can be affected by other firms, changes in consumer tastes, regulatory guidelines in the industry, costs of raw materials to make the product or provide the services, and so on. Good supply chain management allows firm to maintain their competitive position through market power and ability to negotiate better pricing for materials and services better than competitors; allows firms to anticipate customer changes and provide the agility and flexibility needed to respond to the changes; and allow a firm to meet required regulations in doing business. Firms with agile supply chains have better capabilities to respond to changes. Product Life Cycles – As stated in a firm’s competitive position, good supply chain management allows a firm to respond to different needs when a product progress through its life cycle. There will be usually higher needs when a product is first introduced versus lesser needs when a product is in its decline stage. Good supply chains adjust to both scenarios. Supply chain activities which affect A/P include: Negotiated Payment Terms – See statement in A/R section. Labour costs – If these costs rise, business may “postpone” paying suppliers in order to have sufficient cash to pay later. This could affect the relationship with suppliers; suppliers can withdraw trade credit due to untimely payment, which could greatly increase the need for working capital and could degrade the C2C as well as a solvency crisis. If suppliers accommodate the longer payment period, then the C2C is improved. Manufacturing costs – The same effects would occur as described with labour costs. Sales Growth – See statement in A/R section. Float – Float management involves controlling the collection and disbursement of cash. The objective in cash collection is to speed up collections and reduce the lag between the time customers pay their bills and the time cash becomes available. This directly affect by supply chain processes. In many cases exchange of payment will not occur until items deliver to their end destination or a customer receives rendered services. Any delays in the supply chain process of receiving products or rendering services will result in delays in “settlement” (a term used to denote when customer service needs are rendered and payment is transacted and satisfied). Delays will drive up costs and hurt goodwill, which can result in decreased future revenues. Tight W/C availability – When the business is not collecting it’s A/R according to its payment policies, inventory is not moving appropriately and expenses are increasing, business get into a “cash crunch” which requires more borrowing. There are increased costs from borrowing and increased opportunity costs due to alternate investment opportunities for the cash tied up in A/R and inventory. Supply chain processes can help free up cash from these current assets, which will reduce costs and create more “free cash flow”. Free cash flow is a term used to denote cash remaining and available after operational, debt, and equity requirements of the owners are met. Free cash flow is used to purchase more capital equipment and invest in new products and business opportunities for the firm. Free cash flow is also an indicator of financial health and viability, and those firms with more free cash flow have increases in the stock price and greater enterprise value, which is the projected price or worth of a firm. Unprofitable Operations – Unprofitable operations tend to cause a business to increase its leverage or debt in relation to its equity, which increases its credit risk and drive up its cost of credit. Unprofitable operations could be a possible sign that the business and its supply chain are not meeting customer expectations. Unprofitable operations could also mean that there has been a shift in the market characteristics in a product or service, and the business and supply chain strategy must adjust to the change in the market. Unplanned Purchases – Unplanned purchases or “maverick spend” affect company cash, increase costs and undermine supply chain relationships. Tax Liabilities and strategies – Cheaper labour and taxes influence site selection by firms to locate facilities in foreign countries. These new facility locations have created additional supply chain costs, due to increased inventory in transit, increased transportation costs, increased supply chain risk and increased landed costs. Cyclicality – See statement in A/R section. Seasonality – See statement in A/R section. How to Calculate the Cash To Cash Cycle So far, we have talked conceptually about the C2C, but we have not learned to calculate it yet. Here is an example of computing the C2C: Example – A/R DOH = 45 days – Inv DOH = 60 days – A/P DOH = 30 days – C2C = 45 + 60 – 30 = 75 days (Takes and average of 75 days to get cash spent and back into the firm) A/R DOH stands for accounts receivable days on hand. A/R DOH shows the amount of accounts receivable available that supports the sales of the firm. As stated earlier, accounts receivable can grow due to the growth in sales and/or loosening of credit policies for customers. As general rule, one would desire a proportional growth in receivables with the growth in sales. For example, a 10% growth in sales would possibly need a proportional growth in receivables of 10% to support the sales growth. One would not want a growth in A/R and have a downturn in sales growth, because this would indicate the business is not collecting its A/R. The decrease in sales decreases cash in the firm, and the A/R DOH increasing ties up working capital, which also decreases available cash. One can compute A/R DOH in several ways: Formula One: A/R DOH = Average A/R/Sales *365 days Formula Two: First, calculate receivable turnover, which is the number of times A/R turns in year. Next, divide the number of days in a year by the receivables turnover. Receivables Turnover = Sales/Average A/R A/R DOH = 365/Receivables Turnover Both formulas will give the same answer. Example: Sales – 1,000 Ave. A/R – 200 Formula One: 200/1000 *365 =.2 *365 = 73 A/R DOH Formula Two: Receivable Turnover = 1000/200 = 5 A/R DOH = 365/5 = 73 Inv DOH stands for inventory days on hand. This shows the amount of inventory available to support daily sales. Inventory is listed on the balance sheet at cost, so we use the cost of goods sold to reference the amount of inventory available; in essence we compute Inv DOH based on cost of goods sold rather than the sales price. Like with A/R DOH, we just enough inventory to support sales and not too much. Increases in inventory should correlate with increases in sales; one would not want inventory increasing or remaining the same and sales decreasing. One can compute Inv DOH in the same manner as A/R DOH, except we use cost of goods sold (COGS) rather than sales: Formula One: Ave. Inventory/COGS *365 Formula Two: COGS/Ave. Inventory = Inventory Turnover Inv DOH = 365/Inventory Turnover Example: COGS – 500 Ave. Inventory – 100 Formula One – 100/500 =.2*365 = 73 Formula Two – 500/100 = 5 (Inventory Turns) Inv. DOH = 365/5 = 73 A/P DOH stands for accounts payable days on hand. This shows the amount of time it takes a business to pay its suppliers. Accounts payable (also known as “trade credit”) is listed at cost on the balance sheet, so we COGS to reference the time the business takes to pay suppliers. Unlike A/R and inventory, many business like a high amount of A/P because delays in disbursements make more cash available to a firm. In the cases of the C2C, an extended accounts payable actually increases cash. The problem here is that business can lose trade credit, which essence is interest-free financing if they do not pay suppliers according to payment terms. This loss of trade credit would impact the cash position of the firm greatly, because the firm would need much more working capital cash to operate. A firm needs good supplier relationship management to keep suppliers happy and keep trade credit intact. To compute A/P DOH: Formula One: Ave. A/P/COGS *365 Formula Two: A/P Turnover: COGS/Ave. A/P A/P DOH = 365/A/P Turnover Example: COGS – 500 Ave. A/P = 100 Formula One: 100/500*365 =.2*365 = 73 (A/P DOH) Formula Two A/P Turnover = 500/100 = 5 A/P DOH = 365/5 = 73 We can now calculate the C2C from our examples, which is: 73 + 73 -73 = 73 days. This means that it takes 73 days to cash back from the time we pay for merchandise to the time we collect on the sale. Adding the A/R and inventory together gives us what is called the operating cycle. So, the C2C is the difference between how long it takes us to operate and collect the cash. If the C2C is positive, this is also the amount of working capital that needs to be financed. As we stated earlier, working capital is financed by a combination of short-term debt (A/P and short-term financing) long-term financing and equity. The longer the C2C, the more financing that is required. Changes in the C2C serve as an early warning measure. A lengthening of the C2C can indicate that the firm is having trouble moving inventory, or collecting its receivables. A high A/P DOH can mean excessive use of trade credit, which could strain relationships with suppliers. We have learned based on the aforementioned information that the supply can positively affect the C2C, and can impact the business in a profound manner. Using the Cash To Cash Cycle to Detect Supply Chain Problems The C2C gives a lot of information on how the business and the supply chain perform, but we need to able to the information to a more granular level and discern what could be causing the issues with the C2C. There are situations in the business which affect the working capital accounts (A/R, inventory and A/P), which affects the C2C. These situations affect the working capital accounts:   Increases/Decreases in Accounts Receivable are caused either by sales growth/decline or increase/decreases in A/R DOH.  Increases/decreases in inventory are caused either by growth/decline in the cost of goods sold or increases/decreases in Inv. DOH.  Increases/Decreases in Account Payable are caused either by growth/decline in the cost of goods sold or increases/decreases in A/P DOH) The example below shows an example of the effects of management actions on accounts receivable. The numbers we gleaned from the balance sheet and income statement of a firm in 2001 and 2002. In order to find out what caused the changes year over year (YOY) in A/R, the following formulas help us to discern the story:  Find the % change in sales growth year over year (Cur Sales – Prev Sales/Prev Sales): We take the sales of the current year (in the case 2002), subtract the previous year sales (2001) and divide by the previous year. This will give the change in sales on a percentage basis.  To see the effect of sales growth (Sales Change % * A/R from the Prior Year): We take the calculated sales change and multiply that by the A/R from the prior year (2001). This will give the increase/decrease in A/R due to sales growth.  To see effect of DOH (Compute Avg Daily Sales {Annual Sales in current year/365} * Change in A/R DOH): Here we compute the daily sales in the current year (2002) by taking the annual sales in the current year (2002) and dividing it by 365 to get daily sales. We get the change in A/R DOH by calculating the A/R DOH for current year (2002) and subtracting the A/R of the previous year (2001). This will give the impact on A/R due to increases/decreases in A/R DOH. Example (A/R) – 2001 Sales: 7747 2002 Sales: 6806 – A/R (2001): 436 A/R (2002): 1440  Compute A/R DOH for 2001 and 2002 – 2001: 436/7747*365 =.0562*365 = 20.513 – 2002: 1440/6806*365 =.2115*365= 77.197  Compute Daily Sales (2002) – 6806/365 = 18.646   Compute Sales Growth (2001-2002) – 6806-7747/7747 = -12.15%  A/R Growth (Sales Growth) = -.1215 * 436 = -53  A/R Growth (DOH) = 18.646 * (77.197-20.513) = 1057  A/R Growth = 1057-53 = 1004  Total A/R (436 + 1004 = 1440) From this example one can see that A/R increased substantially from 2001 to 2002. Sales actually decreased by 12% from 2001 to 2002, which decreased A/R by 53. But A/R DOH increased by almost 57 days from 2001 to 2002 which actually increase A/R growth by 1057. The total A/R growth was 1004, which increase A/R from 436 in 2001 to 1440 in 2002. The numbers only tell part of the story. We know that when A/R increases, there should be a proportional increase in sales. But there was a drop in sales, so this is not a good thing. If we looked back at our supply chain effects on A/R, this could give us some clues or reason why A/R increased and sales decreased. Were the changes due to:  Changes in negotiated payment terms?  Credit Policies?  Slow Paying Customers?  Seasonality?  Cyclicality?  Changes in the competitive position of the firm and or the strategy (and/or the supply chain strategy)?  The product life cycles of the firm’s products?  Other issues regarding financing, operations, or regulatory issues? We could continue, but this shows that by understanding the C2C and its effects on working capital, one can better investigate the causes of what ails the business and its supply chain. We can conduct this same exercise with inventory and A/P, except that we would use COGS instead of sales to calculate the effects on these items. You would use the same supply effects to investigate the issues. 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 its 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 known 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 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 receivables 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 favourable 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 for 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 cut-off 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 agree 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.