Financial Accounting Advisory Services...Page 11 Corporate treasury − Managing financial risks in your supply chain Supply chain Financial risk management. Supply chain financial

Financial Accounting Advisory Services

Corporate treasury Managing financial risks in your supply chain

April 2014

Page 2 Corporate treasury − Managing financial risks in your supply chain

Agenda

Supply chain financial risk management 3 What benefits can you expect? 8 Why undertake a supply chain 9 risk management project? Case study – hedging policy 13 How can EY help? 14 About EY 15 Contacts 17


Supply chain financial risk management


Supply chain Financial risk management

Is your supply chain impacted by fluctuations in commodity prices and foreign exchange rates? ► Do you have full visibility of the cost components

of your fixed priced supplier contracts? ► Can you reduce the costs associated with

procurement? ► Are your financial risks well controlled and mitigated

to support supply chain continuity?

EY market insights ► 54% of CFOs agree that lack of visibility across the

supply chain prevents them from having a holistic picture of costs.

► 41% of CFOs believe that financial risks are the biggest risks within the supply chain.

► 52% of supply chain managers believe that lack of visibility into secondary and tertiary suppliers are the biggest risk in the supply chain.

Survey of 423 CFOs and supply chain leaders

Partnering for performance, Part 1: the CFO and the supply chain, EY, October 2013.

Management of financial risks in supply chains is no longer simply about pushing risks out of the organization and moving them further up or down the supply chain. Today, it is necessary to take a more holistic and resilient approach, focused on transparency and efficiency. This means that this issue is a concern to treasury teams as well as procurement teams and chief financial officers (CFOs).

Foreign exchange

Energy prices

Precious and base metal prices

Soft commodity prices

Freight and storage costs Financial risks



Understanding component costs in fixed-price contracts is crucial to improving financial performance in supply chains.

Engaging in fixed-price contracts has become standard practice, albeit a generally very expensive one, because such contracts shift all risks (including a number of financial risks) and contingencies onto the supplier. In addition, fixed-price contracts usually contain various cost components, including: ► Costs of commodity-price hedging ► Transportation costs ► Other insurable and non-insurable risks and, in many instances,

hidden cost components, e.g., system costs and staffing costs ► Supplier added value A transparent breakdown of these components, which would give companies the opportunity to challenge pricing, is not normally provided. The key is to focus on the value-add component (the homogenous element) of fixed prices. The preferred-supplier list should consist of organizations that are able to deliver their added value to the supply chain at the most competitive price and optimize the value (including reduced hedging costs) from the other cost components.

Fixed-price purchase contract

Added-value component

Hedges, contingencies,

insurable costs, non-insurable

costs and other hidden costs

etc.

Can represent up to 75% of the total fixed price



Reduce your hedging costs

The costs of hedging can be unnecessarily significant, especially in the current environment, where counterparty or credit risk is an important consideration in pricing deals. Substantial cost savings can be achieved by: ► Applying centralized risk management principles ► Using financial hedges as opposed to bilateral hedges with

suppliers ► Exploiting relatively stronger financial positions in trade

negotiations ► Achieving volume discounts ► Hedging net positions (after incorporating value-at-risk and risk

correlations) ► Using liquid or competitively priced products

A global electronics manufacturer achieved annual cost savings of US$20m (3% of their annual procurement spend) by managing commodity price risk with financial hedges as opposed to bilateral hedges.



Gaining confidence in supplier risk management strategies and policies and underlying hedge transactions

A global consumer products company restructured their supplier contracts to take on commodity risks with the view to monitor and manage them more appropriately internally.

Obtaining information on the risk management strategies and policies of suppliers and underlying hedges is essential to better ensure supply chain continuity. Understanding how your suppliers operate will give you more confidence in them and knowledge of their potential impact on your business. The information required to ensure financial risks are well controlled, managed and mitigated includes: ► Terms (including counterparties) of master hedging

agreements and the details of underlying hedging trades ► Incidental risks of financial hedges and how these are

proactively managed ► Governance, and control structures and frameworks

underpinning effective and efficient risk management ► Detailed risk management policies and processes applied,

including flexibility within these policies


What benefits can you expect?

Procurement cost reduction

Significantly reduce the costs of hedging financial risks within the supply chain using financial hedges as opposed to bilateral hedges with suppliers, leveraging stronger financial positions in financial hedges negotiating, achieving volume discounts, applying centralized risk management principles and policies, hedging net positions (after incorporating value-at-risk and correlations, and using liquid or competitively priced products).

Visibility Provide increased transparency and comparability of procurement cost components across homogenous suppliers, which will facilitate more added-value based competitive pricing discussions (i.e., effects of any price risk hedging, etc., are excluded).

Transparency

Improve the identification and understanding of financial risks within the extended supply chain, which facilitates and supports effective and consistent risk management across the group. This can help to provide comfort that the financial risks are well controlled, managed and mitigated to support supply chain continuity.

Overall Enhanced supply chain performance


Supply chain Why undertake a supply chain risk management project?

We help companies identify, control and manage supply chain financial risks through tried and tested strategies. This allows businesses proactively to manage commodity and foreign currency risks in a more efficient manner, in turn contributing to supply chain performance optimization.

To reduce costs associated with the procurement of commodities and raw materials, enhancing visibility and transparency of financial risks while promoting compliance and minimizing supply chain failures.

Shared Goal



Our teams assist CFOs and heads of treasury and procurement to achieve competitive, sustainable, effective and cost-efficient financial risk management of the supply chain. Supply chain financial risk management supports EY’s supply chain service offering. This means EY can provide a wider, multidisciplinary team (including supply chain and operations, operating model effectiveness, climate change and sustainability, working-capital management professionals) to focus on all the relevant elements of your supply chain.

Supply chain

Establishing an elective supply chain model and infrastructure

Optimizing global spend and working capital

Managing operational tax and regularly change Managing

environmental and sustainability expectations

Supply chains: ►Competitive ►Sustainable ►Cost-

effectiveness

Cost- efficient risk management

Improving operational agility and responsive-ness

Foreign exchange Energy prices

Precious and base metal prices

Soft commodity prices

Freight and storage costs

Financial risks



Supply chain financial risk management forms part of our corporate treasury proposition, which covers the areas of strategy, planning, implementation and quality assurance as detailed below.

Organization and governance

Assurance and control

Cash and liquidity

management

Corporate funding

Valuation and accounting

Performance assessments

Treasury technology

Treasury management

Financial risk management



Questions for CFOs and CPOs

Do you recognize these issues?

Self-assessment

Yes No

Can you reduce your procurement and hedging costs? � �

Do you have full transparency over financial risks within the supply chain and the cost components in fixed-price supplier contracts? � �

Are you convinced you are making the right buying decisions? � �

Are you confident that your suppliers are managing the financial risks in the supply chain appropriately? � �

Can you evaluate the performance of your current hedging decisions? � �

Could you benefit from having more flexibility in financial risk management in the supply chain? � �

Clients generally answer “no” to each of these questions; however, by further analyzing them, the answers form the basis for developing a business case to start hedging or trading.


Case study – hedging policy

Background A global electronics manufacturer, operating in more than 100 countries around the world.

Challenges ► Deliver value to the business by

reducing procurement and hedging costs

► Management support to manage additional financial risks internally using financial hedges with banks

► Optimize risk management of all financial risks

► Effective interaction and communication between procurement and treasury

Options and solutions ► Development of a global commodity hedging policy and risk management

framework, including the design and operation of the controls and procedures

► Options for different hedging strategies, e.g., negotiating floating price with suppliers and hedging it with fixed price with banks via financial derivatives

► Assessment of resources (people and IT) to execute, manage, control, account and report commodity derivatives

► Alignment of different stakeholders (procurement, finance functions, business units) through effective communication

► Application of hedge accounting to derivatives and other technical support ► Definition of KPIs, and performance assessment and measurement

Value to the business ► Procurement costs reduced by 3%. ► Additional cost savings of 8% identified by having commodity price risk managers to manage the commodity price

risks within certain parameters, and physical commodity managers to manage the procurement of the commodity efficiently.


How can EY help?

Our service aims to reconfigure supply chains to drive cost-efficiencies and improve your organization’s operational agility and responsiveness to changes in the business or the market.

Our approach is based on designing and implementing a bespoke financial risk management strategy, focused on the following elements: ► Governance and structure, including the

business case supporting the revised financial risk management strategy

► Process and resources, including system requirements

► Funding, working capital and reporting ► Accounting and regulatory requirements This approach helps ensure that all aspects of your organization impacted by supply chain financial risk management are considered, and the impact of a new risk management strategy is minimized.

Supply chain financial risk management

► Organization structure ► Operating model ► Governance frameworks ► Strategy and policy ► Risk vs. performance indicators

► Operational processes, controls and resources

► Efficiency in purchase and commodity management

► Procurement vs. treasury

► Risk frameworks ► IT system

functionality and end-to-end processing

► Hedge accounting vs. fair value

► Regulatory, direct and indirect tax, and legal requirements

► Benchmarking against leading practice

► Working capital requirements and forecasting

► P&L and cash flow modelling Management reporting, including risk analysis

► Information management


About EY


Your regional EY network

Africa Angola, Botswana, Cameroon, Chad, Congo, Democratic Republic of Congo, Equatorial Guinea, Ethiopia, Gabon, Ghana, Guinea, Ivory Coast, Kenya, Madagascar, Malawi, Mauritius, Mozambique, Namibia, Nigeria, Rwanda, Senegal, Seychelles, South Africa, South Sudan, Tanzania, Uganda, Zambia, Zimbabwe

Belgium and the Netherlands

Germany, Switzerland and Austria

Commonwealth of Independent States Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Russia, Ukraine, Uzbekistan

Central and Southeast Europe Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, Czech Republic, Estonia, Greece, Hungary, Kosovo, Latvia, Lithuania, FYR of Macedonia, Malta, Moldova, Montenegro, Poland, Romania, Serbia, Slovakia, Slovenia, Turkey

France, Maghreb and Luxembourg Algeria, France, Luxembourg, Monaco, Morocco, Tunisia

Financial Services Organizations Belgium, Channel Islands, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Switzerland, the UK

India Bangladesh, India

Mediterranean Italy, Portugal, Spain

Middle East and North Africa Afghanistan, Bahrain, Egypt, Iraq, Jordan, Kuwait, Lebanon, Libya, Oman, Pakistan, Palestinian Authority, Qatar, Saudi Arabia, Syria, United Arab Emirates

Nordics Denmark, Finland, Norway, Iceland, Sweden

The United Kingdom and Ireland The UK, the Isle of Man, the Republic of Ireland

EY Global

Countries worldwide 150

Employees worldwide 175,000

US$ revenue (2012–13) 25.8b


Financial Accounting Advisory Services contacts – EMEIA

Craig Kennedy Corporate Treasury [email protected] + 44 20 7951 9026

Lynne Counsell Commodity Risk Management [email protected] + 44 20 7951 8294

Olivier Drion EMEIA Corporate Treasury Leader [email protected] + 33 14 6937 914

EY | Assurance | Tax | Transactions | Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. © 2014 EYGM Limited. All Rights Reserved. EYG no. AU2301

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This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com

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Financial Accounting Advisory Services...Page 11 Corporate treasury − Managing financial risks in your supply chain Supply chain Financial risk management. Supply chain financial