Leveraging technology to accelerate the accurate matching and approval of both paper and electronic invoices, specialist financiers and forward thinking banks are recognising that in this risk-reduced environment there is an exciting arbitrage opportunity to provide supply chain finance, a compelling way of winning new customers and generating important new revenue streams. This innovative approach results in a "win-win" situation for both large corporate purchasers and small and medium sized enterprise (SMEs) suppliers, whilst creating an exciting new asset class for financiers with an enhanced risk- adjusted return.

Although the web-based technologies supporting e-invoicing have been available for a decade, more than 85% of invoices are still printed on paper and distributed by post. With paper commercial documents the key challenges are reducing processing costs and accelerating the matching and approval process. As we have seen in sections one and two of this guide, improved paper conversion and matching technology can be used to solve this disconnect. Once this has been achieved, specialist financiers can capitalise on the timely availability of matched invoice information in electronic format to reduce costs for both payers and their suppliers through sharing the benefits of structured factoring and invoice discounting programmes.

From a supplier's treasury perspective providing trade credit to customers is a necessary but inefficient use of capital. By allowing a trade debtor to delay settling outstanding invoices a creditor earns no interest. Recognising that "cash is king", trade creditors are keen to reduce their Days Sales Outstanding ratios (DSO), since this is an important measure of an organisation's operational efficiency in bringing cash into the business more quickly. It is for this reason that many corporates offer early payment discounts in an attempt to shorten the trade cycle and get paid more quickly by their customers.

A widely used trade term in commerce is " 2/10 net 30", which means that if a debtor pays an invoice within 10 days of its issue date he can deduct a 2% discount and pay just 98% of the face value of the invoice. In fact, the payer is getting an impressive 2% return for a 20 day investment. This equates to a massive 36% annualised rate, assuming these 30 day invoices are paid on the 10th day. This serves as a powerful reminder of the high value a business places on getting paid quickly and improving its cash flow.

There are not many treasurers who can achieve a 36% return on safe financial investments, so he might be well advised to consider using surplus cash to effectively reduce the cost of goods by taking this discount as often as possible. For a corporate with credit capacity, there is an arbitrage opportunity here: A treasurer can borrow at say 6% and use the funds to achieve a 36% return on early payment discounts, with an interesting profit margin. As we will see later, there are also exciting ways of achieving benefits by partnering with banks to finance the supply chain. Early payment discounts are actually more profitable for a buyer than extended Days Payable Outstanding (DPO) and they are more acceptable to a supplier.

But the fact remains that many AP departments are not sufficiently well structured to take advantage of these favourable trade terms, since it takes more than 10 days from invoice date to process and approve an invoice for payment. Looked at globally, trillions of dollars of value are currently locked inside the financial supply chain in the Purchase-to-Pay cycle. The desire to unlock this value is a fundamental reason why the efficient processing of paper and electronic invoices is attracting attention. An invoice data capture capability able to submit validated and matched invoice data to a corporate ERP within a few hours of receipt of paper invoices is of great value to the payer as well as the supplier: The payer can capture the early payment discount and the supplier gets paid within less than 10 days, with significant cash flow benefits, as well as freeing up trade credit limits and hence allowing more sales to the same customer.

Even in those situations where today suppliers are not offering early payment discounts, an efficient invoice management structure positions a corporate to negotiate dynamic discounting with its supply chain. In fact, Gartner predicts that by 2009 at least 30 per cent of the Global 2000 will have adopted dynamic early payment discounts as a standard practice in AP (source: Gartner, June 2005).

There is a fundamental conflict of interests in the financial supply chain, since the working capital management objectives of buyers and suppliers differ widely. This is an age-old problem: Suppliers want to get paid quickly and hence reduce their DSO. On the other hand, at the other end of the scale, buyers typically want to delay paying as long as possible, ie extend their DPO. This scenario is felt most acutely by SMEs where cash flow is often critical, so they are particularly hungry to get paid quickly.

There is an important role for financiers and banks to play here in making the financial supply chain run more efficiently and in optimising working capital management. Traditionally banks have offered payments & cash management services. Forward-thinking banks are increasingly launching new value-added services, to streamline invoice processing and provide supply chain finance, to oil the wheels of the trade cycle. A bank is uniquely positioned to provide cost reductions and improved control in each part of these processes by positioning itself at the heart of a corporate customer's financial supply chain. A bank's integration into the financial supply chain positions them to deliver powerful working capital managment solutions which benefit both buyers and suppliers.

For some corporates a potential drawback of seeking early payment discounts is that the corporate making the early payment has to use its own valuable cash resources to capture these discounts. Furthermore, many large payers are currently unable to take advantage of early payment discounts because of the processing time required for approvals, before even considering whether or not the payer wants to use its own cash to obtain these discounts. An enhancement of this model is to work with a financier who bridges the funding gap in order to solve that timing conflict between buyer and supplier whereby the buyer wishes to delay invoice payment while the supplier wishes to get paid as soon as possible. Forward thinking banks and financiers are now seeing the benefits of helping implement enabling technologies as part of their supply chain finance programmes.

Specialist financiers have been amongst the first to participate in this structured financing opportunity. The combination of web-based technologies and supportive financiers now enables a supplier to get paid early without using the cash of the payer to make this early payment of the trade debt. At the maturity of the invoice the financier's advance is reimbursed by the payer. The supplier can choose whether or not to take early payment of invoices, according to their cash flow needs.

There are a range of variations on this theme, including non-recourse finance to the supplier, achieving an extremely valuable off balance sheet source of funds for the supplier. This is possible, always with the payer's full agreement, where the invoice data capture system has already achieved a successful match of the invoice against a PO and ideally a GRN. The matching of these vital elements to a trade transaction enable a financier to reduce his risk in making an advance, since he has a high degree of confidence that the goods being financed have been ordered by the payer and have been received by the payer, which greatly increases the probability that the payer will in due course pay for the goods. This "belt and braces" approach of using valuable trade data from both the buyer and the supplier enables the financier to minimise the risk of fraud, an age-old problem in conventional factoring where more than one supplier has been known to present false invoices and request finance.

In the trade model where the supplier is a SME and the buyer is a large corporate with a high credit rating (say A-1 / P-1 for short term commercial paper issues), there is an exciting opportunity for interest arbitrage between the credit quality of the payer and the supplier. Importantly, all parties to the transaction can benefit here. The financier, having reduced the risk of non payment of the invoice through automated matching against a PO and GRN, can afford to offer competitive rates of interest to the supplier for early payment of the invoice. This would typically be finance at a rate of interest lower than the supplier might normally achieve on early payment discounts, factoring facilities or overdrafts). Furthermore, the amount of capital available would exceed the levels of commercial overdrafts, if the latter are indeed available. This approach therefore reduces the cost of funds for participating SMEs and enables them to free up working capital quicker to produce more goods and increase their sales.

The efficient capture and processing of invoices delivers large volumes of matched, approved invoices within a rapid SLA, creating a much greater financing opportunity: More invoices, a longer financing period and reduced lending risk, due to PO / GRN matching.

Key benefits for financiers can be summarised as follows:

• Cost reduction from the current model, facilitating supplier adoption
• Enhanced risk-adjusted return on capital
• Competitive product, encouraging supplier adoption
• Reduced risk of fraud by using payer and supplier data
• Processing efficiency for all parties in the supply chain
• Improved visibility and transactional control
• Suitable for securitisation, due to asset quality of payers.

Through its unique positioning within the financial supply chain, a bank can utilise important trade data at different stages of the trade cycle in order to deliver value to its customers; for example, being aware that invoices have just been matched against purchase orders and goods received notes enables the bank to deliver finance to the supply chain in a timely and competitive manner. Similarly, just as a purchase order is issued to a vendor based overseas, a bank is well placed to make available pre-export finance, either through its own branch network or via its partner banks. This enables exporters to finance sourcing or manufacturing as well as reducing their DSO, while the buyer is able to retain and potentially extend his DPO, with the bank in the middle bridging the funding and timing gap. These innovative supply chain finance structures complement existing factoring and invoice discounting products, as well as international trade finance solutions.

In structuring supply chain finance, banks need to ensure that the accounting treatment of the trade payables on the buyer's balance sheet is not adversely affected. It is crucial that the trade payables should not be converted into bank debt, ie an obligation on the buyer to repay the financier at maturity of the invoice. If the accounting treatment changes to bank debt, there will be a highly negative effect on the buyer's own debt gearing and potentially on its own credit ratings, which would render the model unattractive from the buyer's point of view. The accounting status as a trade payable can be assured through a number of structured financing techniques, such as a robust legal framework and managing settlement of all the corporate's trade payables at invoice maturity (whether financed or not), possibly through a third party service provider. The requirement to respect the absolute maturity of the invoices to the very day and make settlement on the due date can be regarded by some large corporates as something of a straightjacket, but the benefits far outweigh the discipline of settling invoices on the due date.

A number of benefits are available to a large corporate in partnering with a financier to enable the financial supply chain to get paid quicker. In some cases, the financier can make available to the large corporate payer a revenue share or the financier might wish to sponsor a benefits programme. This is effectively a reward for giving the financier visibility to the approved invoices, so that the financier can offer early payment finance to the suppliers for outstanding invoices. Alternatively, the payer and the financier can agree extended credit terms, whereby the supplier gets paid by the financier either within a few days or at the normal invoice maturity date but the payer is allowed to delay settlement of the invoice until a later date, thereby achieving for example 30 days additional trade credit. Under this structure, the large corporate payer might be expected to pay interest for the extended credit period taken, reflecting his own credit quality. On the other hand, some financing structures will simply ensure that this additional trade credit is absorbed into the overall pricing charged against the supplier.

The potential to extend supply chain finance is enormous, spanning both domestic and international trade. Paper invoices from China or Eastern Europe could be scanned locally and matched against POs and GRNs in the UK in a timely fashion so as to enable early payment of invoices to suppliers. The vanilla version of this new asset class does not contain a conditional bank guarantee of payment as incorporated within a letter of credit (subject to the timely delivery of compliant trade and commercial documents), which is a costly but highly secure way of providing trade finance. Nevertheless, one can anticipate the development of varying levels of payment assurance, including bank assured payment, which make this working capital solution an extremely flexible financing tool, likely to enjoy a bright future.

It will not have escaped the thinking of specialist trade financiers that under the new Basel II requirements, structured lending facilities which achieve a high degree of transactional control and make use of techniques such as credit risk transfer qualify for lower capital reserve requirements than unstructured credit facilities to lower credit quality borrowers, such as SMEs. As a result, by transferring risk to the high credit quality names such as large payers with A-1 / P-1 credit ratings at the top of supply chains, the financier can achieve a lower Basle II capital requirement, enabling an enhanced risk-adjusted return on investment.

As mentioned, it is particularly specialist financiers who are willing to pioneer this market, since they are able to respond quickly to these structured finance opportunities. But the way is now open for commercial banks and trade finance banks to adopt this approach, given the availability of web-based technologies and proven invoice data capture services capable of processing these transactions on a large scale. This new source of revenue could prove particularly attractive to banks at the current time when they are in search of value added services to shore up their revenue streams from other traditional areas: The new regulations on EU payments and the infrastructure investment required to comply with SEPA (Single euro Payment Area) are resulting in significantly lower profitability forecasts for many EU banks in payments & cash management. So it may prove good timing that just as forward-thinking banks are tending to combine their cash management and trade finance lines of business that they are now in a better position to exploit the arrival of Purchase-to-Pay solutions on a scalable and dependable basis, through white-labelling partnerships with service providers.

In the long term, end to end e-invoicing looks set to become widely accepted and we remain fully committed to this important market development, but at the current pace some of us will already have retired before this end game becomes a working reality. The challenge of bridging the gap between ingrained legacy paper working practices and e-commerce should not be underestimated. In the short and medium term, the successful solutions are proving to be those which enable the migration from paper to electronic, at a pace to suit each organisation, with roll-out in bite-sized chunks.

As described in this article, there is significant value to be unlocked from the supply chain by improving visibility of trade processes and enabling suppliers to get paid quicker. However, this is only possible in an environment which in an accurate and timely manner enables invoices to be approved and matched against POs and GRNs, hence reducing the risk of non payment of the invoice at its maturity. The underlying theme of this guide is that by "getting it right" in terms of streamlining invoice receipt processing and the visibility of approval workflow, a corporate can not only cut its costs significantly but can also position itself to improve its working capital management across the enterprise. So a well planned Purchase-to-Pay strategy can become an important part of the journey to optimised working capital management.

The supply chain finance principles described in this guide have been articulated by a number of specialist financiers over recent years and a number of pilots and schemes have been established. But these have generally failed to reach the critical mass they deserve. Usually they have been hindered by high set-up costs, a shortage of electronic invoices in the scheme or by the difficulty of achieving an efficient process for approving matched invoices in a short enough time frame to allow a sufficiently long credit period before the maturity date of the invoice. This conundrum can now be solved through the combination of an accurate and timely paper and electronic management service and innovative financiers ready to help buyers and suppliers extract maximum value from the financial supply chain. Such an approach results in bottom line benefits for all participants in the financial supply chain.

Fabien Jacquot