Unlock cash flow in your supply chain

Many businesses in supply chain management overlook the impact of currency fluctuation on cash flow, focusing instead on production effectiveness.

However, during a typical 90-day fulfillment cycle, numerous economic, social, and political factors can influence currency markets. Often, despite effective delivery on an order and prompt payment from clients, market movements can impact cash flow. 

Let’s examine how balancing cash inflows and outflows can help you create a strategy to help lower your inventory costs and unlock your global growth.

Are there foreign exchange variables in your business cycle?

Managing the currency markets

Based on potential market events, this chart scenario outlines the fluctuation in the US dollar against the euro over a typical 90-day fulfillment cycle.

Understanding how these potential FX variables can impact your business can go a long way towards helping you plan and improve your cash flow.

Three key factors to unlock your supply chain cash flow

Imagine if you knew what all your future payables were, and you had confidence that your receivables would come in on time. How much freedom would that knowledge afford your business?

Many elements can help your business maximize your working capital efficiency, including these key ones:

• Understanding the timing of payables and receivables to help maximize all available discounts or opportunities
• Minimizing the amount of cash tied up in idle inventory
• Maximizing payables and receivables to help manage your cash flow

Timing of payables and receivables

Many businesses extend their “days payable outstanding” (DPO) to help maximize their free cash position. Often, paying sooner is beneficial. For example, you may be offered a discount for early payment, or there may be an opportunity to leverage a favorable foreign exchange rate.

However, cash flow forecasting is more art than science. A sound business decision to pay today may no longer make sense if an anticipated receivable fails to materialize when expected and you’re forced to cover overhead.

One of the keys to a successful payables strategy is visibility of all your outstanding cash flows, so you can respond to opportunities when presented. A current view of cash on hand and all payables and receivables due can help to understand potential costs and which opportunities to take advantage of.

A shift in foreign exchange rates is one such opportunity. To find out if you can acquire inventory at a discounted price, ask the following questions:

• Do I have the cash on hand to take advantage of this lower price?
• If I use pending receivables to cover the cost of additional inventory, will I have sufficient funds when needed in the future?
• What percentage of those pending receivables are typically paid early for a discount, on time, or late?
• If I had to borrow to cover the cost of the cheaper inventory, at what point do the lending costs nullify the foreign exchange cost advantage?
• Can I lock in the current exchange rate to use for future inventory purchases?
• Can I simulate scenarios that help me make informed decisions about what strategy to take?

Reducing the amount of cash tied up in inventory

Inventory optimization is typically viewed as a function of right-sizing inventory level and supply- chain responsiveness. This includes balancing inventory on-hand with near-term demand to keep as little cash tied up in idle inventory as possible.

Instead of describing right-sizing in terms of inventory units alone, it is critical to consider the cost of acquiring the inventory and the corresponding payment terms. If you can acquire the same amount of inventory for less and hold the funds for longer, then you may be able to reduce the cash trapped in inventory and improve your free cash position.

The variables are similar when using either domestic or international suppliers, quality and cost of the product, and time to deliver.

When engaging with international suppliers, the cost variable may be impacted by currency fluctuation, and the time-to-deliver variable may impact cash flow.

For example, you are forecasting sales and will need 100,000 units of inventory 90 days from now. You have two suppliers, with different unit costs and payment terms to choose from:

The German supplier is the lower-cost option. The payment terms would enable you to hold your cash for a longer period.

To help protect the cost savings offered by the German supplier, you may want to consider hedging the invoice amount so that you know the true cost of your inventory before payment.

Market movements could favor you and further lower your inventory cost. Alternatively, negative market movements could negatively affect your growth prospects.

You will need to consider your risk tolerance level when determining the size of your exposure. There are multiple strategies that you can deploy, from a forward contract to a comprehensive hedging strategy.

It’s important to note that hedging products are derivative financial instruments, which may expose your business to risk should the underlying exposure you are hedging cease to exist. If you are not confident about your understanding of derivative financial instruments, or foreign exchange and related markets, we strongly suggest you seek independent advice before deciding to use these instruments.

Lowering inventory costs with foreign suppliers

Managing payables and receivables in the supply chain

Companies that sell their products in international markets can also optimize their working capital. Once agreements are signed with clients, you can forecast your budget and manage liquidity. If you haven’t paid for the inputs to your finished product before a sale, your margins may be exposed to currency risk.

Time delays between when you need to pay your supplier versus when you receive funds for the product sold are intensified by currency fluctuations and can erode your margins.

As part of your pricing strategy, you may want to consider employing a personalized hedging policy to help protect your business growth against potentially unfavorable market movements.

Developing a hedge policy

To manage your payables and receivables, consider developing a hedge policy by answering the following questions:

Should I sell my currency on the spot market?

Converting currency and initiating transactions when your invoices are due may provide the opportunity to participate in favorable market shifts. It also may expose your business to negative currency fluctuations, which can make it difficult to see the true cost of an invoice until it’s settled.

Do I lock in expected revenue now?

Even though your foreign receivables are expected in the future, you can lock in the rate today. Knowing your true costs in advance can help you leverage early payment incentives or purchase more inventory if currency movements make it advantageous. It’s important to note that locking in the rate today may prevent you from participating in favorable market movements later.

Should I consider a partial hedge?

A common approach is to hedge a portion of the receivable and transact the remaining portion when the funds arrive. This may provide some protection while offering the opportunity for participation in favorable market moves. It’s important to consider that you may be obligated to exchange a portion of the underlying funds.

Managing your cash flow

Your final sale price reflects the cost of goods sold, while margins depend on the costs of variable inputs. To help manage your cash flow, consider these important questions as part of your strategy:

• Have you paid for the inputs yet?
• Have you hedged your unpaid foreign currency inputs? Or are your accounts payable exposed to market fluctuations?
• If you have hedged the receivable, do you have sufficient flexibility when your client elects to pay early or late?

Gain the security of knowing that wherever the market moves, you can take strategic steps to support your cash flow.

Hedging tools for supply chain cash flow

It’s not uncommon for companies to accept currency fluctuation as a cost of doing international business. But this does not have to be the case. Currency risk management can help businesses manage the effects of market volatility on cash flow. 

A reality of responsible risk management is that ensuring certainty around your cost today can occasionally limit your ability to take advantage of favorable markets at a later date.

Working with a foreign exchange specialist allows you to assess your business objectives and identify the right combination of hedging tools to help meet your goals. This includes tools that can offer protection from negative market shifts while potentially allowing you to participate in favorable currency movements.

Learn more about Convera’s hedging tools, including forward contracts, FX options, and FX swaps. 

Make capital work for your supply chain

Incorporating cash and risk management strategies into your efforts to help drive production effectiveness can offer significant opportunities to expand your business across borders.

Whether your client pays on time is not the only factor to consider within the standard 90-day fulfillment cycle. Even if you can ensure that goods are delivered on time and you receive payment promptly, fluctuating currencies can still eat into your forecasted budget. Considering foreign exchange and its role in the timing of payables and receivables, appropriately managing your inventory and receivables to account for currency fluctuation can help you position your business for growth.

Currency risk management should be considered an integral part of any international supply chain strategy, as it helps position your organization for end-to-end success in the global marketplace.