Master Thesis in MSc. Finance Dan Xu Brentsen The Impact of Supply Chain Finance on Corporate Performance: Improving Supply Chain Efficiency and Increasing Profitability Advisor: Anders Thorstenson Submitted 19 April 2012 1

Acknowledgement I am heartily thankful to my thesis advisor, Anders Thorstenson whose encouragement, guidance and support from the initial to the final level enabled me to develop an understanding of the subject and finish it successfully. It has been an honor to work with him. Anders, your contributions, detailed comments and insight have been of great value to me. I would specially like to show my gratitude to the coordinator at Siemens, Alexander Gorker who has been so supportive for giving me valuable suggestions, support, and insights. Thanks Alexander with your kind help for practical knowledge. I contacted you several times by emails for additional information and you always responded to me right away despite your busy schedules Thank you very much for that. Lastly, I offer my regards and blessings to all of those who supported me in any respect during the completion of the project. Dan Xu Brentsen Business and Social Science, Aarhus University April, 2012 2

Table of Contents Abstract ............................................................................................................................. 4 Chapter 1 Introduction ...................................................................................................... 5 1.1 Backgrounds and motivations ................................................................................ 5 1.2 Problem formulation .............................................................................................. 7 1.2.1 A general framework of research .................................................................... 8 1.2.2 Research questions ........................................................................................ 10 1.3 Research methodology ......................................................................................... 13 1.3.1 The research process ..................................................................................... 13 1.3.2 Hypothesis, testing methods and research questions .................................... 16 1.4 Delimitation ......................................................................................................... 17 1.5 Thesis outline ....................................................................................................... 18 Chapter 2 Literature review ............................................................................................ 18 2.1 The development of supply chains ...................................................................... 19 2.2 The link between supply chain and financial flows ............................................. 20 2.3 Supply chain finance ............................................................................................ 22 2.4 The integration of SCF into SCM ........................................................................ 23 2.5 Financing suppliers in the supply chain ............................................................... 25 Chapter 3 Financial supply chain management .............................................................. 26 3.1 Financial-SCM and the link to economic value added ........................................ 27 3.2 Integrating SCF into payable processes and cash flow cycle .............................. 28 3.3 FSCM performance indicators and profitability ratios ........................................ 31 3.3.1 FSCM performance indicators ...................................................................... 31 3.3.2 Key profitability ratios .................................................................................. 33 3.4 The impact of FSCM on corporate performance ................................................. 37 Chapter 4 Empirical Analysis ......................................................................................... 39 4.1 The sample selection and data description........................................................... 39 4.2 Hypothesis tests and testing methods .................................................................. 42 4.2.1 One-sample distribution tests and t test......................................................... 43 4.2.2 Correlation and regression analyses .............................................................. 44 4.3 Data analysis and interpretations ......................................................................... 45 Chapter 5 Case study at Siemens .................................................................................... 52 3

5.1 Supply chain finance at Siemens ......................................................................... 53 5.2 FSCM indicators, profitability and growth at Siemens ....................................... 57 5.3 Recommendations ................................................................................................ 63 5.3.1 Updates in the ERP system ........................................................................... 63 5.3.2 Control of payment terms and SCF loans to suppliers .................................. 64 5.3.3 Extension to emerging markets ..................................................................... 68 Chapter 6 Conclusions .................................................................................................... 70 6.1 Criticism ............................................................................................................... 70 6.2 Suggestions for future research of interests ......................................................... 71 6.3 Conclusions .......................................................................................................... 72 References ...................................................................................................................... 74 Appendix ........................................................................................................................ 78 4

Abstract The thesis studies the application of supply chain finance (SCF) in supply chain management. The SCF is also called supplier finance, and mainly it is used to deal with the financial issues in supply-side value chain management. The impact of SCF on corporate performance reflects in the improved supply chain efficiency in terms of cost saving payable processes and payment term extension. The performance indicators derived from the financial supply chain management (FSCM) have influences on profitability. On the SCF program, decreased costs of goods sold (COGS) obviously can increase return on invested capital (ROIC) and return on equity (ROE) in short term. The cause-effect relationships between the FSCM performance indicators and profitability are established by the EVA model and tested in linear regression analysis. The popularity of using the SCF program is increasing after the financial crisis (2008) because of the imminent beneficial consequences. Small participants can take large participants credit ratings to finance their capital requirements on the SCF program. Together with early discount payment, the small participants are able to save financing costs as well as increase cash and speed up cash flows. Large participants can extend payment terms to attain positive cash flows and to increase economic value added. Additionally, the large participants can leverage the small participants cost savings to negotiate better price offers and in turn to reduce their own COGS. The supply chain finance is a financial solution that provides win-win outcomes for all the participants in the supply-side value chain. Particularly in the economic recession, the positive impact of SCF on corporate performance can increase corporate economic power in the marketplace and remain competitive. 5

Chapter 1 Introduction In this chapter, backgrounds of financial shortages in international supply chains and motivations of using supplier finance to assist on supply-chain improvement are introduced. The problem formulation includes a general framework of research and research questions. The research methodology includes research methods and the research process. Delimitations about the critical choices are argued in order to magnify the accuracy of research results. The structure of this paper is outlined at the end. 1.1 Backgrounds and motivations Alongside the trend of globalization, companies are oriented to produce international product, which will be sold globally, thus coordinating with international suppliers all over the world is inevitable. With this trend companies increasingly focus on their core capabilities, effective and efficient supply chain management (SCM). It has become a key constituent of corporate strategy, competitive advantage, and success (Narasimhan and Talluri 2009). Since 2008 the financial crisis has resulted lots of banks or financial institutions in confronting serious credit risks, which subsequently bring liquidity tightening, bank runs and even bankruptcies. Absolutely, this issue will affect their financing activities to companies. In the meanwhile the international business has also faced to a big challenge, because trading partners are ought to seek for alternative capital financing sources or approaches. Dynamic discounting, early discount payment and lengthening payment terms are crucial for corporates to deal with insolvencies and remain competitive at the same time. In the history of trade finance, factoring and letter of credit are often applied to help the international business partners manage cash flows. However, the impact of financial crisis will amplify counterparty risks and increase transaction costs. Problems of aging payables and increasing credit risks have become the main reasons to cause inefficiency in operational and financial performances. The supply chain disruptions in relations to supplier defaults can have long-term negative effects on a firms financial performance. Hendricks and Singhal (2005) show that companies suffering decreases in 33-40% lower stock returns relative to their 6

industry benchmarks because of supply chain glitches cased by suppliers. Furthermore, the impact of supply chain performance on financial indicators has also been revealed by Avanzo et al. (2003) from financial accounting points of view. The risks in the supply chain management associated with volatility and supplier failure had increased 54% between mid-2007 and mid-2008 (Kerle 2010).The importance of supply chain risk management is illustrated by the results of a recent survey, which reveal that 90% of films felt threatened by supply-side risks (Snell 2010). The whole supply chain contains the inbound and outbound logistics through business processes from suppliers to final customers. Here, the study focuses on inbound material activities with suppliers through manufacturing operations and financial services with suppliers through the upstream flow of cash. Accordingly, the financial issues caused by the level of supplier-buyer relationships are considered as basic assumptions to explore part of supply-side risks. An empirical Demica report (2011) studies the growth trend of a financial solution on supply-side trade relations. It is used to 1) improve cash flow management, 2) reduce risks of supplier failures in supply chains and 3) improve transparency of transactions between suppliers and buyers. Supply chain finance program has gained attentions since the financial crisis. The SCF program aligns the third party financial services, large and small participants through the open account. It is also called reverse factoring, and it is a process that the large participants help the small participants receive lower cost of capital financing by sharing credit lines. The SCF program provides also the early discount payment to the small participants. The introduction of SCF into SCM, i.e. financial supply chain management (Michael 2009) will help companies consolidate the competition in the marketplace by means of generating real cash flow benefits. Farris and Hutchison (2002) emphasize a cash-to-cash cycle time as an important indicator in supply chain management metric. Additionally, Bhagwat and Sharma (2007) consider the total cash flow time as an element into the balance scorecard (BSC) measurement model. However the failure to relate key measures to performance drivers brings obstacles of applying BSC to track the cause-effect relationships between performance indicators and further improvement of corporate value. 7

Lambert and Pohlen (2001) use the EVA model to integrate the supply chain operational processes to financial performance. Gomm (2010) embraces the key performance indicators for both supply chains and financial flows in to a single corporate performance evaluation based on the EVA model. The EVA model works also on capturing how the companies drive value and profitability including the cost of capital in the supply chain. Wang (2010) has conducted an empirical analysis to test the impact of the SCF program on corporate performance before financial crisis. The improvements of operational and financial indicators can be observed in short term. Kerle (2010) has further provided the evidences of maximizing the current scarcity of liquidity by applying the SCF program. IMDs survey (2009) shows over half of respondents have admitted the implementation of SCF to SCM can help improve supplier relations1. 1 http://www.imd.org/research/publications/upload/PFM178_LR_Ralf_Daniel_Seifert.pdf Supply Chain Finance - Whats It Worth? , www.imd.org, no. 178 October 2009. The positive outcomes by applying the SCF program in supply chain management are recognized. The study interests of this thesis are to explore the impact of the SCF program and the effects of development on short term corporate performance; the impact around the time period of financial crisis is considered. The EVA model will be used to identify the most important indicators and ratios, and build up their cause-effect relationships. The SCF program is initiated by the large participants in supply chains, so the improvement of their corporate performances is significant. Furthermore, reducing supply risks in terms of enhancing supplier liquidity are also expected to be investigated. 1.2 Problem formulation In this section, a general framework of research is created containing the financial issues in supply-side value chain and the application of a financial solution for improvement. The introduction of the SCF) program is able to help the international business partners conquer financial constraints and develop cash flow efficiency. The subsequent research questions are designed to explore the possibilities and to explicate the outcomes. 8

1.2.1 A general framework of research In the house of supply chain management in figure 1, there are two business partners under the roof, one is the supplier and the other is the buyer. The buyer is considered stronger than the supplier under the circumstances. The impact of financial crisis destroys the usual balance of inbound logistic business processes between them, in particularly the upstream flow of cash. Therefore, the lack of efficiency in supply chains causes the difficulties in the flows of financial resources between organizations. In order to increase liquidity, the supplier promotes terms on early discount payment with cost of money and the buyer applies dynamic discounting method with upfront cash reserves. This method works all right when the situation is not extremely downside in the financial crisis. When the bank runs occur often and in turn affect the financing activities to companies, the buyer starts to consider lengthening payment term in order to fulfill internal financing on working capital needs. Indeed, the dynamic discounting method is redundant for the sake of holding cash reserves. This phenomenon results the supplier in complexity of managing its account receivables. Eventually the supplier will borrow money from other financial factors with higher credit costs in order to further operate the business processes. In the meanwhile it is not rational anymore for the supplier to offer early discount payment, because the lower credit ratings may lead to bankruptcy at the end. The consequence of supplier failures in the supply chain is expensive; hereby the resolution to help the buyer and the supplier live on from the transitory overwhelming turmoil is a further contribution of this study. The introduction of the SCF program in the supplier-buyer trade relations breaks the door to the next level of supply chain management financial supply chain management (FSCM). 9

Figure 1: Financial issues on supplier-buyer relationships in supply chain management and benefits of applying the SCF program Supply Chain Management Supplier Buyer Materials Cash Early discount Payment Higher cost of capital Worse credit risks Dynamic discounting Lengthen payment terms Risks of supplier failures Financial Crisis Financial Institution SCF Programs FSCM Financial Resources SCF Programs FSCM Better financing cost (early discount payment according to buyers cost of money) Alternate source of liquidity (to securitize cash flow with buyers credit rating) Reduced disputes of payable processes More predictable cash flows Improved credit rating to avoid default risks To negotiate payment term extension with suppliers and improve economic value added. Reduced operating process costs and increased standardization of process Better cash flow management Improved supplier-buyer relationships Benefits for supplier Benefits for buyer Sources: Authors creation 10

We can see in figure 1, the application of the SCF program brings a new financial solution to supply chain management, considering the third party financial services. The reverse factoring allows the buyer to help the supplier receive better terms of capital financing through the IT platform provided by the financial provider. The SCF program is a superior solution for the supply-side value chain management. Both the buyer and the supplier can benefit on the SCF program. Most importantly, the buyer can pursue a tactic strategy to lengthen payment terms without extracting extra costs from the supplier as well as improving the economic value added (EVA). As for the supplier, lower cost of financing and speed-up cash flows are the most significant achievements. Supplier risks are mitigated as the supplier strengthens its cash flow and as a result it has a better liquidity which is especially helpful in the financial crisis; eventually the supplier can improve its credit rating and become stronger in the marketplace. The SCF program has the insight of becoming popular concerning the positive outcomes from the perspectives of both the buyer and the suppler. The financial crisis is seen as a significant driver of interest in SCF, because corporates as well as their financial institutions are seeking to free up cash flow in supply chains while reducing risks. Undoubtedly, the SCF program has the competence to develop the flows of financial resources in supply chain management. 1.2.2 Research questions In this paper, two main research problems are expected to be answered: Does the use of the SCF program in supply chain management have a positive impact on short-term corporate performance in the time period of financial crisis? How come the contribution of SCF programs can help companies improve profitability as well as control supply-side risks?

To answer these questions, studies on supply chain management in connections to financial flows and supplier/buyer relationships are required as fundamental knowledge. The deep understanding of integrating SCF into SCM has a decisive role. Furthermore, the link between performance indicators and financial ratios based on the EVA model 11

provides a framework for cause-effect relationships. The strategic financial solutions provided by the SCF program can help build up a successful buyer-supplier partnership in terms of pricing, payment terms and controlling supplier risks. Several sub-questions are required to be studied regarding the main research problems: 1) What is the SCF program, and how to integrate SCF into SCM? 2) What are the performance and financial indicators on the program and how to derive the indicators? 3) Could the application of the SCF program have the impact on short-term corporate performance? 4) What are the relationships between financial supply chain management (FSCM) performance indicators and profitability? 5) What is the practical application of the SCF program in the supply-side value chain management? 6) How could large participants use the SCF program to cooperate with small participants? 7) What are the expected outcomes by the application of the SCF program? 8) What are the most significant benefits and achievements for business partners on the SCF program?

The use of SCF program is new in the international business; therefore there are no standard procedures to measure the effects of corporate development with SCF. In this study, it starts with embracing this financial solution into supply chain management and derives important FSCM performance indicators and profitability ratios, in order to measure possible outcomes. The FSCM performance indicators are obtained by investigating the value drivers in accordance to supply chain business processes; the profitability ratios are derived by investigating the financial ratios corresponding to profit growth. The selection of the indicators and the ratios is based on the EVA model. The expectations on observing the impact of SCF on short-term corporate performance are settled, corresponding to the findings by Wang (2010). The time of perceiving effects of development is critical, because every financial and operational solution takes time to implement, sometimes mid-term and sometimes long-term. See the elicited paragraph from Novozymes annual report. It takes Novozyme 2-3 years to observe the effects of development on the supply chain finance. 12

Cooperation with Suppliers The target for 2007 was to develop a step-by-step procedure for how and when to further develop cooperation with suppliers on issues of sustainability. In line with this target, we developed a new method in 2007 for responsible purchasing that considers the risks and opportunities in our supply chain. Our target for 2008 is to carry out a pilot test of this new responsible purchasing model in all regions with the aim of implementing it in 2009. Novozymes annual report (2007) The contribution of this research is about to help business partners seek a superior financial solution for solving supply chain cash flow issues in the crisis (See section 1.2.1). The financial crisis in 2008 is not so far away from now, so the mid-term effects are difficult to detect at this moment. Additionally, some companies may adapt to the program after 2008. Furthermore, in Wangs paper two-year time interval outcomes are not different from the findings for one-year time interval. Therefore, the assumption of the short-term positive impact of SCF is logical. If this is true even around the financial crisis, then the expectation of using the SCF program is more realistic. The immediate positive outcomes are able to show that the SCF program is efficient to help the business partners live on from the transitory overwhelming turmoil. The EVA model is also used to build up the cause and effect relationships between the FSCM performance indicators and profitability. The exact correlations between them are expected to be explored by further empirical analysis. Concurrently, the significant FSCM performance indicators in terms of explaining the effects on profitability are drawn by statistical tests. Case study of SCF at Siemens provides the practical application of the program. Discussions at this stage embody further understandings of theoretical findings and modified explanations of empirical results. In the meanwhile, the achievements on supplier-buyer partnerships with SCF are argued from different points of views. The predicted benefits acquired with SCF for large participants are essential. It gives possibilities for using SCF to assist on the development of the value chain as a whole. It will lead to win-win outcomes to all the participants in supply chains. The large participants will support credit enhancement techniques to the small participants reducing default risks, which can cause supply chain shortfalls. The small participants can get lower cost of capital financing and speed up cash flows. The improved payment term negotiation as well as standardization of payable process can help consolidate long-term successful cooperating partnerships. 13

Applying the SCF program is not only to achieve superior competences but also enhance the synchronized level between operational business processes and financial flows in supply chains. It is orientated to develop advanced inter-organizational collaboration and communication, meanwhile the competition of the value chain as a whole is more severe than individuals in the economic recession. 1.3 Research methodology Seen in last section, the research questions are outlined regarding the impact of SCF on corporate performance by supply-side value chain efficiency; the outcomes are able to be observed in short term. In this section, a sophisticated research process is designed in order to accomplish the research of interests. Research hypotheses, testing tools and analytical methods are introduced accordingly. 1.3.1 The research process The general research process of this study is shown in figure 2. It starts with defining research problems relative to previous research findings and theoretical framework for the SCF program. The inter-reactions at stage one contribute the formation of hypothesis tests and empirical analysis at stage two. The intention of stage three is to figure out the practical application and relate to previous findings as a result of feedbacks. Because there are no standard research procedures conducted so far for the SCF program, the combination of theoretical, empirical and practical researches are comprehensive to summarize the outcomes. The theoretical background is used to identify the FSCM performance indicators and the profitability ratios which will be used in the empirical analysis. The interpretation of the analytical results is used to confirm the significance of the selected indicators and ratios. Sometimes the analytical results do not provide the expected solutions, if so, then further discussions on the application of SCF will also rely on the practical application. All in all, the final conclusions of this research are determined based on various findings and arguments. The research methodology is designed in accordance to both qualitative and quantitative methods (Kothari 2011). Quantitative research is conducted by analyzing a random 14

collected sample, in which certain research hypotheses will be tested. Qualitative research is conducted by case study at Siemens with interviews and Q&A. Designed qualitative research questions are outlined. The data are randomly collected from public resources (Hendricks and Singhal 2005). The events of signing the SCF program in companies are searched through the public resources by key words, such as supply chain finance, trade finance, agreement. The full text of articles should contain combinations of these keywords. Announcements from the websites of SCF financial institutions are options too. The data will be sorted by differentiating the key figures of the year after and before the event. The final dataset contains different variables in columns that used to present the selected indicators and ratios, and the companies in rows. The data analysis will be done by IBM SPSS Statistics version 19 and R-2.14 programming. The case study of SCF at Siemens depends on interviews and follow-up questions. The introduction of SCF at Siemens and the implementation of SCF to its suppliers are used as case references. Further communications regarding the qualitative research questions are required. The summary of qualitative research experience is about to provide sufficient practical conclusions besides the theories and the empirical results (Assadej et al. 2010). Financial accounting data is applied for both quantitative and qualitative research methods, because the impact of supply chain financial solutions on corporate performance is expected to be observed from the companys financial statement. The SCF program is used as financial solution to enhance supply chain efficiency, and the record of supply chain business processes are often related to operational figures. Furthermore, the focus of the study is to explore the impact of SCF on short-term corporate performance from both operations and financial flows. It explicates the processing procedures in organizations. It is more robust than studying the impact as an event on stock markets only, which cannot imply the effects of development on operational performance (Hendricks and Singhal 2005). The financial account data contain the information of corporate financial structure such as cost of debt, which is related to annual interest rate of corporate loans not the dynamic changes in stock markets (Berk and DeMarzo 2007). To improve the cost of 15

money is a significant contribution by the SCF program because of cash flow efficiency in supply chains (Camerinelli 2009). The financial accounting data might be useful to analyze the events that reveal the corporate performance (Tomaso et al. 2010), and the measurement based on accounting may apply only within the context of a specific predictive purpose or prediction model (William et al. 1968). Figure 2: The flowchart of research process with detailed tasks at each stage Clarifying research focuses in terms of research of interests and research problems. Understanding performance indicators and profitability ratios, the EVA model, the SCF, SCM, and the benefits of applying the SCF program. Designing a research process with statistical methods and qualitative research methods. The framework of empirical study is about to derive cause-effect relationships between FSCM performance indicators and profitability. The case study at the company is about to modify the usefulness of applying the SCF program. Linking possible outcomes to the research problems.

Define Research Problems Review Concepts and theories Review Previous Research Findings Formulate Hypothesis Collect, Analyze and Interpret Data Formulating research hypotheses according to literature reviews in terms of the research framework. Conducting an empirical analysis with the quantitative research method, alongside descriptive statistics, t test, correlation tests, and regression analysis. Reporting analytical results which should give evidences to pursue research of interests and answer part of research problems, if not, preparing further reasonable statements. Summarizing useful results for further application.

Applications and Practices Feedback Preparing a qualitative research to explore the use of the SCF program in practices in relations to theory and analysis. Applying significant outcomes from both qualitative and quantitative research to outline the most significant indicators for improving corporate performance. Referring to the research problems with the solutions of applications and practices in order to verify the quality of the study and the contribution of the research.

III II I Sources: Authors design 16

1.3.2 Hypothesis, testing methods and research questions Referred to the main research questions and sub-questions, the purpose of this study is about to figure out the positive effects of using the SCF program on the corporate performance. The verifications of selected FSCM performance indicators and profitability ratios, and their relationships are required. Seen in Demica paper (2011), the program has been well known since the financial crisis, so the year as a representative of increasing popularity is also important. In general, there are four research hypotheses will be tested on the subject of quantitative research method: : The application of the SCF program has a positive impact on short-term corporate performance in economic recession. : The FSCM performance indicators and profitability are correlated. : There are cause-effect relationships between the FSCM performance indicators and the profitability ratios. : The popularity of applying the SCF program is increasing. Descriptive statistics will be used to observe the basic shapes of all the selected variables. Following, to detect the sample outliers by Boxplot (John Tukey 1977) is fundamental. The existence of outliers can distort linear estimators. The first hypothesis can be tested by one-sample t test (Aczel 2006), which is used to discover the significant impact of SCF based on the selected variables. The correlation tests with Pearson, Kendalls tau_b and Spearmans rho are applied for testing the second hypothesis. The significant correlated relations are used to give the evidence of conducting linear regressions. The third hypothesis will be done by regression analysis in order to establish structured linear models for profitability. The cause-effect relationships are implied in cross-section estimation. The forth hypothesis is involved in the regression analysis. Case study of SCF at Siemens is done by qualitative research method. The endowment of qualitative research experience is vital to modify the analytical results in empirical studies. Four subsequent qualitative research questions are necessary: 3 Are the selected FSCM performance indicators and profitability able to present the impact of the SCF program in practices? 4 How could the SCF program benefit large participants? 17

5 Can the application of the SCF program help small participants lower cost of financing and speed up cash flows and in turn control supplier risks? 6 Is the win-win outcome true?

All the practical questions are argued with respects to the theoretical and empirical findings. Together with a basic evaluation of the selected variables by Siemens accounting figures, the most significant FSCM performance indicators and profitability are able to be prioritized. The improvement of supply-side cooperation is studied by the methods applied at Siemens. At the end, the benefits for Siemens and its suppliers on the SCF program are highlighted. Qualitative data are gathered primarily in the form of spoken or written language rather than numbers. The data resources are from the interview and follow-up Q&A with the coordinator at Siemens. The interview focuses on the introduction and implementation of SCF at Siemens. The data from the interview will be transformed into written text for further analysis; the subsequent Q&A will be done by emails. The interpretation of qualitative data is not very complicated, and it is done by the self- reported technique. 1.4 Delimitation There are limitations to conduct the research of the SCF program on the corporate performance: 1 The study concentrates on companies instead of banks or financial service providers. The banks or financial service providers are responsible for the development of the SCF program in international business. From the companies points of view, applications of the SCF program and its contributions to the supply-side partnership improvement are fundamental. 2 The time period around financial crisis is very special, and the SCF program is just one factor that can help companies to recover from the economic recession. The influences of the program on corporate performance could be partial, even though the expected outcomes specified by literatures are optimistic. 3 Negative cash flow cycle technique is not covered in this research. The application of the SCF program is to optimize the capital utilization, but not to use customers and suppliers as sources to have interest-free cash financing in business processes. 18

4 The announcements of supply chain finance are not easy to be found by public resources, so missing data in the random sample collection is unavoidable. Some announcements are lack of event year, so they cannot be used. By contrast, some companies may not announce the events in the public, although they have already applied it as a financial solution in supply chain management. 5 The dominant power in supply chains can be revealed by either suppliers or buyers. It depends on their company sizes. Usually larger/stronger participants on the SCF program are somehow prevailing to affect supply chain solutions.

1.5 Thesis outline The thesis outlines in six chapters. Chapter 1 is the introduction containing research settings; the problem formulation and the research procedure provide a guideline which is related to the follow-ups in coming chapters. Literature reviews are in chapter 2; main theoretical and empirical references are discussed here. Theoretical study of the SCF program in Financial-SCM is in chapter 3; FSCM performance indicators, profibatility ratios and their cause-effect relationships are derived based on the EVA model. Empirical analysis of the selected indicators and ratios is in chapter 4; the impact of SCF on short-term corporate performance and the effects of development on profitability are interpreted based the analytical results. Practical application of SCF is in chapter 5; the case study of SCF at Siemens provides in-depth understandings of the selected indicators and ratios, and the win-win outcomes of using the SCF program. Conclusions are in chapter 6; criticism and suggestions for future research of interests are stated. Chapter 2 Literature review In this chapter a framework of supply chain finance and its integration to supply chain management will be introduced first. The impact of financial crisis brings new challenges as well as new opportunities to the development of supply chains. The link between supply chain and financial flows is considered as an inevitable strategic solution while improving corporate performance. The introduction of supply chain finance to the supply chain management is able to help corporates remain competitive 19

and increase economic value added. Ideally, the effects of development are possible to be observed in short term. Ultimately, the win-win outcomes will benefit both large and small participants. 2.1 The development of supply chains Nowadays the supply chains have been developed more complicated as the business has become more international. The term of supply chain management is first introduced by U.S. industry consultants in the early 1980s (Oliver 1982). The expansion of physical capabilities in international logistics has started since the early 1990s, and the trend of global economic integration becomes evident everywhere. With the development of e-business, communications between suppliers and buyers become instant by information systems. For example, the buyers can have access to any suppliers irrespective of location and available at any time. It reduces costs, improves service levels and increases profits. The improved communications through new technology are the enablers of supply chain integration. The popularity of international integration brings the new challenges to the management of multiple relations in the supply chain. This also leads to a broad inclusive view of logistics, which is not only responsible for one to one business, but a network of multiple businesses and relationships. It is extended to combine all related activities into a single integrated function Waters (2007). There are many researchers have studied on various processes of in supply chains. Lambert and Cooper (2000) point out that a successful SCM requires a cross-functional integration in the firm by coordinating activities of the key business processes. The links of business processes have direct effects on the levels of decision making, such as operations and financial planning, supplier risk and customer services management. Thus, analyzing and designing an efficient and effective supply chain have gained an increasing attention, and models of evaluating supply chain performance are diverse as investigated by Beamon (1998). He implies that a traditional supply chain is characterized by a forward flow a materials and a backward flow of information and finance. 20

Farris and Hutchison (2002) have emphasized the cash-to-cash cycle concept to the supply chain management perspectives. It contains three important leverages which are account payables, account receivables and inventory. In the meanwhile, the idea of cash management has also been sentient in supply chain business processes. Badell (2005) addresses that the financial flow optimization in operation processes will satisfy shareholders as well as improve supply chain efficiencies. Cash flows are involved in each supply chain business process and the optimization of the financial flows is required at each stage. It shows the necessity of managing financial flows in the supply chain business processes, and it is significant to implement the financial-SCM strategic plan. It heightens the decision-making capacity of the CEO and the CFO in complex scenarios. The cash inflows and cash outflows in supply chains are strongly dictated to the capital capacities in companies. The synchronized level between supply chain management and the financial flows can be seen as indicator to measure the operational efficiency and as a result the financial liquidity in the companies. 2.2 The link between supply chain and financial flows There are many companies have not noticed the disconnection between overall business strategy and supply chain strategy in the organization; financial, information and physical flows are seldom synchronized. However, economic growth and capital utilization in the firm are expected to be optimized through the integration of information, financial and physical supply chains. The strong interdependency between operations and financial departments enables corporate to maintain competitive advantages in industries. Seen studies on financial flows in the supply chain, certain part of researchers are orientated to have applied cost models on the basis of accounting theory, such as Activity-based costing (ABC) that was introduced by Kaplan and Cooper (1988a,b). This has been broadly applied in multi-level, manufacturing organizations. In the 1990s many companies move their concentrations on competitions to reduce their own costs as well as those of related partners in supply chains. The competitions among companies rely on a more cost-effective chain a lower cost to serve the final marketplace and 21

achieved in the shortest time period possible. The ABC tools are not used for the evaluation of financial performance, because delayed payment, return on investment/equity are not concerned as analytical indicators. Therefore, this evaluation tool is not satisfactory enough to be applied at the tactical stage for the overall corporate valuation (Ozbayrak 2004). Balance scorecard (BSC) is also widely applied when conducting performance measurement. Bhagwat and Sharma (2007) summarize some key performance indicators related to day-to-day business operations from four perspectives: finance, customer, internal business process, and learning and growth. Moreover he has considered the total cash flow time as the key measure in connection to the financial performance. However, the case-effect relationships of the key measures to performance drivers are lacking. So the supply chain balance scorecard is not sufficient enough to reveal whether the operation improvements have been translated in order to enhance financial performance. Financial performance in connection to supply chain activities are always seen as cost reduction, market share growth and profit increase (Chien 2007). There are positive relations between financial factors and the innovative supply chain practices: the improved supply chain business processes can benefit organizations through better financial performance; the increased corporation profit and market position are accompanied by an increase of the overall corporate performance. The integration of physical supply chain and financial management with the backward information flow should be done as a one package procedure in corporate. The synchronization is expected to be accomplished by the harmonization between strategic business processes and financial decisions (Guillen 2006). Weissenrieder (1998) has adapted the method of discounted free cash flow (DFCF) to calculate profitability and monitor the economic value added in the company. The analysis of profit or NPV determines implementations of certain projects. But using DFCF method to assess the strategic supply chain decisions cannot maintain sustainable competitive in case that the financial impact on different operational alternatives is not assessed in advance (Lanez et al. 2009). Normally, conventional organizations choose internal financing resources to finance the supply chain and the related business processes. Yet, retained earnings, depreciation, 22

redistribution of capital from the balance sheet of a company do not have cash payments associated. Accounting earnings can present the economic value added in the firm but not the direct cash that are ready to be spent. Many academic researchers have described the differences between financial chain and physical chain in terms of inventory, process and cash management. Yet, the measures on the cost of capital regarding the impact of SCM solutions have not been explicitly considered2, because the financed assets as well as the cost of financing are not normally concerned on the bases of supply chain activities. 2 The cost of capital reveals credit risks overall the company. From companys point of view, the cost of capital, i.e. the weighted average cost of capital is an appropriate discount rate to use for cash flows with risk. As a consequence new tasks at the intersection of finance and logistics/SCM open new business areas for banks as well as financial and logistics service providers (Hofmann, 2005). The new concept about the integration of financial, information and physical flows brings supply chain managers new thoughts to concern the importance of the financial side of business activities. In turn, it gives the new challenges to supply chain executives of speaking the financial languages to communicate on board and in the mean while to build up cross-functional competences. The new trend of inter-organizational interactions and cross-functional relationships provides new opportunities for the development of supply chain efficiency and financial performance. 2.3 Supply chain finance Supply chain finance (SCF) is an approach that aims to improve the supply chain efficiency. It is intended to improve payment terms, to reduce costs and to accelerate cash flows. Overall, the well-gained credit rating to the small/weak participants from the strong/large participants (Myers 2002) and the simplicity of payable processes (Hartley-Urquhart 2000) will enhance the supplier-buyer partnerships. Collaborations between the financial side and the operating side need an encompassing approach. It should not be an isolated concept but rather as an aspect of a more integrated system or program to map the gaps between SCM operating performance and financial performance (Timme et al. 2000). 23

The physical supply chain uses analysis and planning tools to meet and predict future demand as well as international logistics; the financial supply chain incorporates external financial service providers to jointly create value through means of planning, steering, and controlling the flows of financial resources. The SCF program aligns the operational flows with the financial flows (Camerinelli 2009). Pfohl and Gomm (2009) show the SCF program is profitable for both sides in organizations. Supply chain finance can be seen as a financial alternative for supply chain management to better operate a competitive project. The small participants obviously can receive the financial profits in accordance to the difference between the interests of refinancing from the larger participants. It can also help increase the operational benefits by the external financing services. The participants who join the SCF program can have comparative supply chain advantages through the transparency of information and the upgrade of payment terms. 2.4 The integration of SCF into SCM Reducing the financing costs and optimizing cash flows in the supply chain can be seen as the main functions of the SCF program. It is orientated to motivate supply chain development, risk adjustment and value creation through improved operational performances with respect to the reconfiguration of financial resources (Gomm 2010). The levers of the SCF program are volume, duration and cost of money. Benchmark financial indicators using supply chain operations reference (SCOR) model can help supply chain managers to visualize the link between operational performance and the financial statement (Ceccarello el at 2002). The use of Du Pont Model can assist managers to determine the overall impact of operation decisions with respect to cash flows and asset utilization (Kremers 2010). However, none of them is robust enough to cover the issues of capital costs. The use of economic value added (EVA) model in supply chain performance measurement introduced by Lambert and Polen (2001) captures how the firm drives value and profitability from operations inducing the cost of capital. Introducing SCF into SCM based on the EVA model can bridge supplier-buyer related procurement processes. For example, the improvement of cash conversion cycle time and supply chain velocity can enhance the economic profit of a company and additionally have the effect on cost of capital (Hofmann 2003). 24

Nowadays, the supply chain management expands to a scope beyond the operational level of management. The task of SCF is to save the capital cost by means of integrated relationships of partners and advanced financing activities in supply chains. Applying this financial aspect to finance the supply chain gives us a new knowledge on the level of management - financial supply chain management (FSCM). The financial supply chain management is a specific set of solutions and services to expedite the flows of financial resources and information between trading partners (Michael 2009). The development of e-invoicing - paper-free transferring process of payment and the supplementary corporation with third-party financial institutions result in a simplified integrating supply chain procedure. Spoken of the impact of supply chain decisions on financial performance, we often discuss the lack of cross-functional coordination (Carter et al. 2005). Thus a more comprehensive integrated system is a consequence. It is also necessary to use the system exploring if the application of SCF can help corporates enhance the financial performances. Wang (2010) has conducted an empirical study on the impact of SCF on short-term corporate performance. KPIs for both supply chains and financial flows are applied to present corporate performances. He concludes the implementation of the SCF program is mostly used to solve short-term cash flow issues and to reduce operating costs. In the summary, inventory turnover, return on sales and return on equity have been increased at certain significant levels. In addition, the reduced cost of goods sold can increase profitability significantly. The selection of the analytical variables in Wangs paper relies on experience, so it is a kind of empirical analysis on common corporate valuation indicators and ratios by a consideration of SCF application. The introduction of the SCF program contributes financial services to business processes that relate to financial issues in supply chains. The collaborations are based on committing to share the resources, capabilities, information and risks on a contractual basis. Stronger/larger participants are orientated to concentrate on the process optimization and visibility between trading partners; smaller/weaker participants are expected to provide sufficient financial and operating information. 25

Generally, the large participants who initiate the SCF program are intended to increase the economic valued added through payment term extension, and the small participants who join the SCF program are going to enhance the liquidity through financing costs reduction. The improved corporate performance can be observed from profitability, cash flows and credit ratings. 2.5 Financing suppliers in the supply chain The impact of financial crisis exacerbates corporate insolvencies and bankruptcy risks. It affects the progress on sourcing of products, services and capabilities, because of the risks of supplier defaults. The higher supply chain vulnerability with this setting makes supply chain risk management (SCRM) more difficult for many firms (Blome et al. 2011). Companies are oriented to continue tightening credit conditions when doing businesses with each other, thus the liquidity has become inadequate. Large corporations would like to extend payment terms deliberately, in order to maintain competitive for their supply chains. However, small corporations in the supply chains are unable to sustain further lengthening of payment periods because of the risk of insolvencies together with lower credit rating3. Instead, a mutual beneficial process is needed because of the growing intense between business partners. 3 88% of UK firms and 55% of German companies have identified that key suppliers are unable to sustain further lengthening of payment periods (Kerle 2010). Changing suppliers is risky but essential and beneficial for the supply chain under certain circumstances. However, sometimes many supply chains rely on a set of specialized suppliers who are not easy to be replaced, and in the meanwhile it takes long time to build up the new mutual trust supplier-buyer relationships in a short time. Therefore, financing the supply chain is the most effective time-saving strategy. The perception of financing the supply chain has been lasting for decades in the developed economics. Factoring as a financial solution has existed by the form that a company sells its account receivables to a factor (a third party that can provide financing services to the seller) to get the advanced cash to run the business. Normally, it requires good credit information from the seller. But defaults of customers may cause 26

insolvency problems, thus the seller may not have enough reserves to repay the factor, which will pass the burden of default risks to the seller (Klapper 2005). The SCF program (reverse factoring) plays an important role in the progress of financing suppliers through the standardized payable processes. The saved financing costs from the payment terms on the SCF program are really beneficial to improve cash flow efficiency and subsequently improve supplier relations (Dyckman 2009). Reducing costs of capital financing as well as controlling credit risks is the most significant feature of the SCF program. Additionally, the application of open account rather than letter of credit (LC) in international trade condenses the transaction costs in terms of charge fees from banks and increases the cash flow speed in terms of a simplified payment process. By the means of letter of credit, a vendor/supplier has to prepare all the required documentation and then claim the payment from the bank with certain LC costs. The economic crisis brings pressures to both banks and corporates and in turn increases costs of transaction. Through open account alongside the endowment of the SCF program, the vendor/supplier can get paid earlier and foresee the account receivables to manage the cash flows in advance without extra charge fees (Appendix A3). Chapter 3 Financial supply chain management In this chapter, the application of the SCF program in supply chain management including payable processes will be exhibited. The selection of FSCM performance indicators and profitability ratios will be discussed according to the EVA model. Following, detailed arguments on how the changes of supply chain efficiency can have impacts on profitability should be stated. Overall, the whole chapter is extended to provide fundamental theoretical support for further empirical analysis on cause-effect relationships between the FSCM performance indicators and the profitability ratios. 27

3.1 Financial-SCM and the link to economic value added The concept of financial supply chain management is derived from the introduction of supply chain financing programs from the bank or the third-party financial institution with new forms of payable processes and payment terms between business partners. The superior financial services provided by large participants and external financial providers assist on increasing supply chain efficiency as a whole as well as remaining competitive. Mainly it reduces the complexity of payable processes through open accounts and in the meanwhile let small participants take large participants credit ratings to reduce costs of capital financing. Overall it improves short-term liquidity in the value chain and consolidates long-term supplier-buyer relationships. The introduction of the SCF program to supply chain management can be seen as part of the design of financial flows in supply chains. As we know supply chain decisions are usually close to operational management instead of financial management. However the SCF program is a financial solution to develop the supply chain management, and in return the improved supply chain efficiency will enhance financial performance. To explore that, companies are ought to link operational drivers to top level financial indicators. The EVA model in figure 3 is used to link the value drivers from the operations to the financial performance. The EVA model tree leads to 1) the net operating profit after taxes (NOPAT), and 2) the cost of capital. Figure 3: EVA value-driver hierarchy and levers of SCF Sources: Gomm (2010), Supply chain finance: applying finance theory to supply chain management to enhance finance in supply chains. 28

The EVA model seen in figure 3 provides the linking path that takes us from the high-level financial performance towards more specific operational tasks. The EVA model considers the value after subtracting the cost of capital. The capital cost rate is usually defined as the weighted average cost of capital (WACC) which is the minimal required return on the company sustained by both investors and creditors. NOPAT and other corresponding operational and financial indicators will be discussed in the section of FSCM performance indicators and profitability ratios. 3.2 Integrating SCF into payable processes and cash flow cycle By the impact of the financial crisis, the tied-up working capital has become crucial because of the long cash flow cycle time from procurement to sales. Companies are seeking an essential financing method to their own as well as trading partners. However, the conflicted goals between buyers and suppliers increase the complexity to build up a mutually beneficial process. The buyers wish to delay payment for their specific financial situations and the suppliers want to accelerate collections. The application of the SCF program in supply chains can create win-win outcomes for the collaborating partners through simple and fast payable processes. Figure 4 shows how the payable processes work in supplier finance. As seen in figure 1, the buyer is supposed to be the large participate and initiates the upgraded payable processes in the financial supply chain management. Here, the same assumption of company sizes for the buyer and the supplier is used. Mainly figure 4 presents the internal financial and operational management through ERP system in companies4. The agreement established between the buyer and the financial institution contains legal issues, such as transparent data transforming in processes5. In the meanwhile, the buyer has to provide detailed and timely financial and operating information to the financial institution regarding the supplier. 4 The ERP application is business management software and helps in centralizing all data and processes of an organization. It is mentioned here in order to assist on presenting how FSCM works in the organization; however it is not the focus in this thesis. 5 The function of financial institution is very important in SCF processes; however the detailed argument and research are left as future research of interests. The statement related to the financial institution in this thesis is limited in how it can help the participants on the program establish a sufficient financial supply chain, indeed improve supply chain efficiency. 29

Figure 4: Account Payable financing application in accordance with supplier finance 1. Buyer issues a purchasing order to supplier 2. Supplier ships the goods while transmits invoice data to buyer Descriptions: 1) Buyer updates its ERP system to reflect the issuance and terms of the purchasing order (PO) accordingly. 2) The invoice data should be matched with the PO data subsequent to the delivery. When the shipment of goods is verified, again buyer updates its ERP system to reflect the receipt of the goods. 3) Buyer vouchers the account payable (AP) in its ERP system and transfer payment instructions to financial institution for future due payments. 4) Once buyer updates its ERP system to reflect the verification of AP, financial institution is able to get the access to extract supplier profiles and calculate the future payments for supplier based on buyers credit rating and publish them before the due. 5) Supplier admits the early payment option to get cash inflow or receivables with an attractive discount rate. 6) The financial institution sends a payment notice to buyer, and buyer confirms the payment of full amount paid on the due date.

3. Buyer approves suppliers invoice data and sends payment instructions 4. Supplier is notified for future payment through the financial institution 6. Buyer remits the full payment on the due which settles the transaction 5. Supplier may convert the future payment to cash directly Financial Institution Sources: Authors drawing according to the Hartley-Urguhart (2000). Overall it is important to consolidate the financial supply chain into a synchronized system through high degree of information sharing and trust. Financial institution must follow in all the payable and business processes, especially the receipt of goods. It is the trigger for the financial institution to pursue future payment to the supplier. The payable processes built up on the basis of SCF platform have simplified the upstream cash flows in the supply chain between the buyer and the supplier. It liquidates also the tied-up working capital in business processes. The supplier gets paid from the financial institution before the maturity and the buyer pays to the financial institution regarding a lengthened maturity. Generally, the cash cycle time from procurement is defined as the elapsed time between the payments of cash for materials up to the receivables for sales of the finished products, seen in figure 5. The cash flow cycle time highlights how quickly a company 30

can convert its products into cash through sales. A rising trend of the cycle over time specifies the company may be facing a cash flow crisis in the near future. So the cash flow cycle is an indicator to specify the condition of working capital, and it is used to detect non value-adding processing time in the supply chain (Hofmann 2003). In figure 5, from the buyers point of view (blue dotted line) lengthening the days in payables is rational to shorten the cash conversion cycle. From the suppliers point of view (red dotted line) shortening the days in account receivables can help the company lower the cash conversion cycle. The shorter the cash conversion cycle, the healthier a company generally is, because less time capital is tied up into business processes. Figure 5: The operating cycle and its improvement by applying the SCF program Sources: Authors drawing. Time Order Placed Delivery + Invoice Days in Inventory Sale + Delivery + Invoice Days of Sales Outstanding Actual Payment Days in Payables (time period to payment of supplier) Cash Payment Date Days in Receivables (customer payment time) Expected Payment Date Cash Conversion Cycle Operating Cycle Cash Flow Cycle The improved financial-supply chain performance will lead to an efficient and effective operating cycle with less time consuming (See figure 5). The improved operating cycle can also help generate additional cash flows to pay off the liabilities on time. It provides visibility to a higher quality of earnings, which enables the company to receive a better 31

corporate bond rating, indeed lower the cost of debt. It counts to the improvement of the cost of capital rate i.e. the WACC (See figure 3). Figure 4 and figure 5 have exhibited the application of the SCF program on the basis of cash flow management in supply chains. There is an important outcome on the program. The supplier is possible to receive better offer for the cost of capital financing from the buyer. See the EVA model in figure 3, from the suppliers point of view the lowered cost of capital financing (cost of debt) and shortened cash conversion cycle will indirectly decrease the cost of sales and directly reflect in the cost of capital. If we discuss the savings orientated to the buyers opportunity costs, then it is possible for the buyer to negotiate a better price offer in procurement which will also reduce the buyers cost of sales. The win-win outcomes can be seen from both parties. 3.3 FSCM performance indicators and profitability ratios In this section, operational and financial indicators regarding the SCF program will be discussed broadly based on the EVA model. The selection of important FSCM performance indicators depends on the features of SCF and the value drivers in supply chains. Profitability ratios are chosen in accordance to the key figures that can present growing profits in companies. The cause-effect relationships between the FSCM performance indicators and the profitability ratios are derived by considering the overall impact of supply chain improvements on corporate performance. 3.3.1 FSCM performance indicators Key performance indicators (KPIs) are also known as key success indicators. There are various KPIs that are used for the measurement of financial supply chain management. FSCM performance indicators will be defined from both supply chain operations and financial flows (See section 3.1). Some of the KPIs are determined according to supply chain solutions; some of the KPIs are derived with respects to financial-SCM connection. Timme et al. (2000) summarize that supply chain solutions can relate to annual revenue growth, profitability and capital utilization. They specify profitability as the percentage of profits after subtracting from revenue total operating expenses. Cost of goods sold 32

(COGS) as the percentage of revenue and selling, general and administration (SG&A) as the percentage of revenue are defined as the operational value drivers to improve the financial performance. Capital utilization is the area with the greatest potential for SCM solutions to improve the overall financial performance. The optimization of inventory, account receivables and account payables are the main elements to be considered regarding the features of SCF. Cash conversion cycle seems having the character to build up the connections for these elements (Farris and Hutchison 2002), and it is also one of the value drivers of SCM to improve the financial performance in the EVA model (See figure 3). The long cash conversion cycle requires large working capital in operations, thus to keep this value as low as possible is what the SCF program is ought to contribute (Hofmann 2003). The cash conversion cycle covers the whole period from the cash outflow of paying for production and cash inflow of selling products to customers, seen in figure 5. There are three import components in the process: 1) Days Inventory Outstanding (DIO), 2) Days Sales Outstanding (DSO), and 3) Days Payable Outstanding (DPO)6. 6 Jim Mueller: Understanding the Cash Conversion Cycle, Investopedia, May 16, 2010. Where: thus we have The CCC metric covers the value drivers from both supply chain and financial flows. We can see that shortening the days in inventory, reducing days in average receivables, and extending days in average payables can result in the decrease of working capital requirement in operations. Cost of goods sold is used as a denominator to obtain DIO 33

and DPO, because DIO and DPO are the values related to supplier relationships. DSO is paired with revenue, because customer relationships generate sales/revenue. Inventory is also a value driver to influence the financial performance (See figure 3). Inventory value (IV) is usually recorded as cost, because it is what the company has paid for not sold. Besides the inventory value, inventory turnover (IT) gives more meaning to specify the efficiency of SCM solutions. IT indicates the frequency of replacing or clearing inventories in a company over a period. The higher this ratio is, the better the company uses of inventory and the shorter the time between sales and cash collections. The way of using average value is about to achieve a more conservative estimate during the period of cash cycle (Simchi-Levi et al. 2002). Cost of goods sold is applied to derive inventory turnover, because inventories are purchased from suppliers as part of goods for production. Till now CCC, IT, CR (COGS% of Revenue) and SR (SG&A% of Revenue) are summarized as main performance indicators for measuring financial supply chain management. Based on the EVA model, they are ought to have impacts on the corporate financial performance. The indicators are selected corresponding to the value drives in figure 3. However some value drives are excluded, for they are not related to the study focus and the features of the SCF program (See section 1.1). Later in this chapter, the relationships between the selected FSCM performance indicators and profitability ratios will be argued on the basis of the EVA model as well. 3.3.2 Key profitability ratios First of all, let us see how operating processes and financial structure can be integrated based on the EVA model. The net operating profit after taxes (NOPAT) and invested capital are seen as independent of the companys financial structure and non-operating assets. It is a kind of component that purely symbolizes the impact of operations on financial figures. It can be used to calculate the return on invested capital (ROIC) which assesses how well a company is using its money to generate returns (Koller et al., 2005). 34

If we expand the equation into details including considerations of profitability maximization, capital efficiency optimization, and tax minimization, then we have where , is equal to revenue less operating expenses (e.g. COGS, SG&A, depreciation). All the profits included in NOPAT are available to both debt and equity holders. ROIC is a financial indicator, but it solely focuses on a companys operational drivers, over which the manager has control. The ROIC tree in figure 6 expands the derivation into different operational components. All the operational value drivers are exhibited on the right side of the tree. Operating margin is equal to the gross margin (GM) less SR and depreciation/revenues. Further down, the average capital turns is equal to operating working capital/revenues less fixed assets/revenues. Figure 6: The tree of return on invested capital (ROIC) Gross margin Pre-tax ROIC Cash tax rate ROIC Operating margin Average capital turns SG&A / revenues Depreciation/revenues Operating working capital/ revenues Fixed assets/ revenues S.1 S.2 S.3 S.4 S.5 S.1-S.2-S.3 1/(S.4+S.5) Sources: Koller et al. (2005), Valuation: Measuring and Managing the Value of Companies. 35

The operating working capital is achieved by subtracting current liabilities from current assets7. It is a broad concept to show short-term liquidity in the company. Referred to the arguments in section 3.2, the cash conversion cycle is involved in cash flow cycle (See figure 5), which can be used to specify the condition of working capital in the value chain (Hofmann 2003). Cash-to-cash cycle, inventory and processing time are used to specify the working capital conditions on the SCF program (See figure 3) and all these value drivers are used to derive the cash conversion cycle (See section 3.3.1). 7 Koller et al. (2005). Gross margin is obtained by deducing COGS from revenue. GM implies operational gains by the impact of financial-SCM solutions, and its positive relation to the financial performance is expected. The SCF program helps the company improve supply chain efficiency from financial point of view, thus elements that can be influenced by SCF will be prioritized. Here, depreciation and fixed assets are not explored for further analysis, because they are accounting figures in accordance to asset consumptions in the company. The other part of the EVA model includes a companys financial structure. The capital cost rate is usually represented by WACC, which is the companys opportunity costs of funds and embodies a combined required return from both operations and financial markets. The value of a company is driven by ROIC, WACC, and growth (Koller et al. 2005). If we write the cost of capital in connection to the EVA model as follows: and the EVA in figure 3 could be obtained by subtracting the cost of capital from NOPAT, so we have A strong ROIC indicates high growth. When ROIC is greater than WACC, the company creates value to both stakeholders and shareholders, and when ROIC is less than 36

WACC, the value will be destroyed. The simplest form of WACC is the market-based weighted average of the after-tax cost of debt and cost of equity8. 8 See Koller et al. (2005), chapter 7. 9 See Chen and Shimerda (1981) and Wang (2010). D/V = Target level of debt to enterprise value using market-based values E/V = Target level of equity to enterprise value using market-based values = Cost of debt = Cost of equity = Companys marginal income tax rate Mainly WACC contains the market-based values; however the accounting figures are used to study the impact of SCF as a financial-SCM solution on the corporate performance. It is irrational to merge accounting data and financial market data together conducting empirical analysis, because the financial market data is more dynamic than the accounting data to reflect on the company events (See section 1.3.1). The inefficiency in the analysis will generate biased solutions. Fortunately, the cost of debt has relations to the cash flows of business processes (See section 3.2). So, further improvement of WACC will rely on the studies of the cost of debt. Other financial ratios that represent the growing profits are outlined as return on equity (ROE), return on sales (ROS) and return on assets (ROA)9: Return on sales is related to the determination of NOPAT in the EVA model. Although the associations between ROS and supplier finance are not apparent, the net income as the numerator to obtain this ratio explains the significance of reducing SG&A and COGS by the use of the SCF program (See section 3.3.1). 37

Return on assets gives both stakeholders and shareholders an idea on how efficiently the company is earning more money on less investment in operations. The increase of ROA indicates that the company can convert the liabilities it has to invest into net income proficiently. In a sense, we may expect companies who are with SCF can amplify the utilization of liabilities by the improvement of payable processes and payment terms. Return on equity measures how a company can generate profits by shareholders investments. It shows the hard fact that if there are enough profits to compensate the risk of being in the business or not. It reveals also the shareholder value in the company. Talking about shareholder value and supply chain solutions together, the design of the flow of financial resources in supply chains can affect return on equity (Hofmann 2003). 3.4 The impact of FSCM on corporate performance The endowment of SCF in supply chain management brings benefits for both suppliers and buyers, including the less time consuming operating cycle and the improved cost of capital financing. The EVA model has been used as theoretical references to derive FSCM performance indicators and probability ratios. It covers both operational and financial performances in corporate valuation. Supply chain value drivers such as IT and CCC, operational value drivers such as CR, SR and GM, and profitability ratios such as ROIC, ROS, ROA and ROE are selected to present the impact of the SCF program on the overall corporate performance. Table 1: The cause-effect relationships between selected FSCM performance indicators and profitability ratios CR SR GM IT CCC Profitability - - + + -