Jonathan Heuser, Vice President of Trade Finance and Supply Chain Services, JPMorgan Chase

Positive economic trends in Latin America have treasurers in the region increasingly looking at their supply chains to get a more accurate picture of organizational working capital. Under the backdrop of Latin America’s economic growth – which averaged 4.5% in 2005 and 2006 and is expected to be about 4% for 2007 – international trade is up, as are capital flows to the region.  

Other factors fueling the region’s growth include lower interest rates and higher prices for commodities such as oil, copper, and agricultural products – goods that are frequently at the center of trade partnerships between the region and its international trading partners.

Effective Management
The key to effectively managing working capital in Latin America – or really anywhere around the globe – involves the ability to improve the efficiency of working capital usage in all operational areas of a company. Solely focusing on traditional approaches to cash management can limit a treasurer’s ability to manage working capital in a holistic way.

Latin American treasurers can do more to manage working capital by looking into functions beyond finance as part of their analysis and planning process. These include areas that are fundamental to growth and profitability, such as procurement, shipping and compliance and risk management. As global growth has companies expanding into a large number of countries, decisions in these areas of the organization can have a substantial effect on the company’s cash position. As treasurers become more involved, they will be better able to help other departments within a company understand the financial impact of what may initially appear to be non-financial decisions. The end result could be impressive gains on the balance sheet.

One of the key places for treasurers to gain more visibility into operational working capital is by striving to understand the nuances of supply chain management and how decisions within the supply chain process can have a profound effect on working capital.

Global View
Today, global organizations in Latin America, like their counterparts in North America and eastern Europe, need to look beyond payables and receivables and reach into the area of supply chain finance to gain a holistic view of working capital. A treasurer’s understanding of the supply chain can help speed up cash conversion. Direct knowledge of sourcing strategies, payment terms, seasonal variations, and transport methods will also allow treasurers to plan cash requirements with greater precision and take advantage of investment opportunities. This understanding will also help the treasurer identify new opportunities to improve working capital efficiency.

Most companies are faced with an expanding number of choices when it comes to suppliers, which span a variety of geographic locations with disparate financing needs and performance profiles. As these sourcing options proliferate and become global, organizations need to think even more strategically about the choices they make.

It is important, for example, for treasurers to understand the unique requirements for buying and selling goods within the three major trading blocks in the region: Mercosur; the North American Free Trade Agreement (NAFTA); and the Central American Free Trade Agreement (DR-CAFTA). NAFTA, in particular, has been beneficial to companies in Mexico. With NAFTA in place, companies based in Mexico have the financial incentive to create relationships with US and Canadian trading partners. As these relationships grow, trading partners can then establish favorable payment terms with each other, for example, rather than rely on more costly documentary trade credits and their associated processing delays.

Procurement is a key area for Latin American treasurers to investigate when they begin the process of looking at the broader supply chain. When selecting a vendor, multinational organizations ideally should include consideration of payment terms and a supplier’s overall financial footing, in addition to the more common considerations of capability, location, and price. 

Decisions about how and when to pay a supplier are typically made within the procurement department and may follow a broad-stroke analysis that largely looks at comparable product offerings and the ability to deliver. Final negotiations are often focused on securing the lowest possible cost of goods or services, but often they do not take into account the impact of payment terms and methods on the ultimate cost of goods. These considerations are often relegated to lower importance on the procurement decision list. Unfavorable terms, however, could have a broader effect on the organization and on its cash flow than procurement staff may realize.

Mutual Consideration
The goal is to assure that procurement staff not only considers its vendors’ ability to fulfill business needs, but also to consider the financial benefits, or risks, that any particular vendor may bring to the overall business strategy. A treasurer should also have a good understanding of the issues the procurement department is most concerned with, including the following:

• The cost of goods – Are you securing goods from the lowest-cost provider and maintaining quality and logistical efficiency? What are the other costs – such as transportation, import or export compliance, duties, warehousing, and distribution – that influence profit margins?

• The impact of sourcing locations, duty regimes, quality and returns – What is the trade-off between cost and geography? Are you aware of relevant trade programs and taking advantage of them? Are you minimizing your customs duty expenses and satisfying export requirements?

• Strategic partnerships and vendor performance – Do you have the right sourcing and supply chain partners? Do you track and monitor their performance? Are your vendors providing you visibility into their supply chain activities? Do you work together in an effective partnership?

• Core versus non-core functions – Which processes or functions, such as compliance, document handling, compliance checking, payment screening or partner management, are part of your core business? What can be streamlined, automated or outsourced? 

Once these issues are understood, a treasurer can partner with the purchasing department, educating staff on the impact their decisions will have on working capital. This will help the procurement team make decisions that offer the greatest benefit to the company.

The US subsidiary of Mexico-based multinational Cemex is one organization that has employed this strategy successfully. Everardo Villarreal, treasurer of the US unit, says: “Aside from the financial benefits such as extending payment cycles, it’s a good exercise to get in touch with different departments. In our case, once we got involved in the supply chain process, Treasury negotiated supplier terms and conditions – the financial nuts and bolts – but at the end of the day, the organizational benefit is that Treasury got together with the procurement department and we worked hand in hand. Departments outside of Finance sometimes work in silos and they forget about the financial aspects.”
Supply Chain Financing

Latin American treasurers should also understand an organization’s cost of capital versus the supplier’s cost of capital. Open account terms, for example, may bear lower fees than a letter-of-credit based transaction, but they can also restrict a seller’s access to working capital financing and increase its costs of working capital. The costs the supplier bears for accepting extended payment terms, for example, could be finding their way back into the cost of goods.

In most cases, longer payment terms place a greater financial burden on the seller, while shorter terms place a greater burden on the buyer. Treasurers and procurement staff should determine which party has the lower financing costs and greater access to capital, and payment terms should take this discrepancy into account.

This situation is particularly pertinent to Latin America. In higher inflationary environments in growing economies, procurement staff may be dealing with suppliers that will not want to have extended receivables if payment terms are already quite long. And some Latin American companies’ ad-hoc collection practices, such as restrictions on when checks can be distributed, can further lengthen the collection process. 

Buyer discounts for early payment may be available or can be negotiated. Often when a company decides to extend payment terms in conjunction with a supply chain financing program, the selling point to suppliers is immediate payment at a discounted rate – but a rate still more attractive than the supplier’s typical borrowing cost. If the buyer is managing and financing the discounting program, the need to turn around payables rapidly can place a heavy burden on the accounts payable staff; accounts payable would then have to generate approved invoices more quickly than they may be capable. A self-financed program also becomes a drain on working capital.

There are a number of strategic financial considerations that should be included as part of the decision-making process. For buyers, is there a better use of balance sheet cash? And for sellers, is it more important to convert receivables to cash quickly? Is a discounted early payment really beneficial to the bottom line? For organizations working in a global environment, currency issues can also affect working capital. Transaction fees, volatility of dollar-based invoices versus a domestic currency and fluctuating exchange rates can complicate otherwise well thought-out plans.

Currency Concerns
Currency issues are particularly relevant for transactions in a global supply chain, and there are many things for Latin American companies to consider. For example, which currency is most efficient for your organization and your vendors – the buyer’s currency? The seller’s? Or perhaps an international exchange medium, such as dollars or euros? Other currency factors that have the potential to impact working capital are restrictions on currency flows, as is the case with Brazil, or onerous transaction reporting requirements.

Treasurers must be prepared to have the hedges they need against currency depreciation or appreciation. Certain Latin American currencies are appreciating against the dollar – most notably the Colombian peso and Brazilian real – and as a result many companies considering supply chain financing are looking to maintain their short positions in the dollar and limit their long positions.

Additional considerations lie with where the company generates revenues and expenses. Are there regional operations that need to be funded, or are profits always returned to the head office? Where are the best investment opportunities for the company and what are its growth plans? What are the tax implications for overseas cash, and what are the costs to move this cash? Which currency does your supplier finance its operations in, and how do suppliers prefer to be paid?

The growing volume of electronic payments represents an opportunity to expedite the cash conversion process. By getting involved with global payments, however, Latin American treasurers will also need to deal with differences between countries based on accessibility of credit, operating infrastructure, payment preferences and industry economics.

Latin American organizations have the additional challenge of having to understand multiple local clearing systems, finding the most efficient payment methods and managing other intricacies of cross-border payments specific to the region. Some countries in Latin America still operate both high-value and low-value payment clearing systems as well as paper clearing systems. Additionally, local structures must also be taken into account, such as the boleto in Brazil, which is a paper-based collection and reconcilement system driven by banks. Mexico, on the other hand, uses a bank code known as a clabe in place of a bank routing number for high-value transactions. Having to work with numerous local structures such as these poses a challenge to the standard processes sought by today’s treasurer.

Through joint planning between finance and the procurement team, systematizing, streamlining, and automating the payment process should be explored. Including suppliers in the discussion of their preferred payment methods can help reduce costs and also speed up the cash conversion cycle.

Risk Management
Compliance and risk management present an additional area of opportunity for the increased involvement of a treasurer. Not being adequately aware of risk exposure, not establishing necessary controls and procedures or overlooking regulatory requirements can expose the enterprise to potential fines and penalties.

But an even greater threat to efficient working-capital management are the uncertainties inherent in the trade process and logistics management. If the transportation network is unreliable, companies must carry extra inventory to create buffer stock. If the distribution network is inefficient, then inventory is delayed or mishandled, leading to shortages and an inability to replenish stock. If goods are held for inspection due to improper or missing paperwork, then the transaction is disrupted and payment is delayed. All of these can result in lost business and hinder cash flow. Also, inadequate import and export compliance procedures expose companies to risks, delays and even increased landed costs.

Ford Motor’s subsidiary in Mexico has already addressed some of these considerations. Estanislao Álvarez, sales director at the Mexican unit, says: “Before looking in depth at our supply chain processes and trade costs, we were adding cost to our imports and exports due to customs duties. So we organized a ‘zero duty task force’ to address these costs and lowered them – mostly due to correct classification of goods we import to and from the US, Canada and South America. All told, we were able to reduce duties by nearly 60%.”

Having mapped-out and managed processes, automated tools, and professional advisory services can create a more secure and compliant global supply chain, thus minimizing the risk of supply chain delays, penalties, rising expenses or the loss of customers.

Conclusions
In their quest to manage and optimize working capital, treasurers in Latin America have the opportunity to bring a greater level of structure and financial accountability to an organization. As globalization increases, technology advances and the number of suppliers and vendors available to an organization proliferate, the need to take a broader view of the cash cycle quickly becomes an imperative.

As treasurers become more aware of the business processes that can impact working capital, they gain expanded visibility and a greater understanding of how they can better manage cash. By understanding the interaction of sourcing, supply chain, finance, and risk, treasurers can employ a broader variety of management tools and thus increase their leverage over the balance sheet.

This comprehensive view is perhaps a complex treasury philosophy, but it foments cross-functional partnership, comprehensive planning, and a more sophisticated – and more effective – framework for working capital management. The result can be more cash for strategic investments, expansion plans or to be returned to shareholders or owners.