Editor's note: Aberdeen Group, in collaboration with World Trade Magazine, recently surveyed a spectrum of our readers on the impact global trade is having on corporate finances. The research sample included respondents with the following job titles: CEO, CFO, COO (34%); vice president (15%); director (30%); and staff and internal consultants (21%). About 24% of respondents were from large enterprises (annual revenues of more than $1 billion); 37% were from mid-size enterprises (annual revenues between $50 million and $999 million); and 41% were from small businesses (annual revenues of less than $50 million).

Most companies have achieved excellent cost control and financial management of their domestic operations. However, controlling global trade activity remains far more challenging. Global supply chain uncertainties-such as delayed or incomplete shipments, freight expediting expenses, unexpected customs fees or fines, foreign currency fluctuations, and unanticipated customer chargebacks-contribute to budget overruns and cash flow management challenges.

For CFOs, working capital cycles are king. As more of the business is tied up in global trade, working capital cycles become longer and harder to manage.

There's multiple reasons for this complexity. More working capital is tied up in inventory to combat longer and more uncertain international lead times, proactive use of accounts payables balances degrades, accounts receivables become slower, and cash movement becomes more complicated. The comments of the CFO of a small U.S. industrial equipment manufacturer typify the experience of others: “We have net-30 day terms with our domestic suppliers, but we've found the standard business practice of our European and Asian customers is to give net-60 and net-90 day terms. This creates cash-flow challenges that we have to be very careful to manage. We're looking to factor more of our international receivables as a result.”

International trade is having a powerful impact on cash flow. The study found that the typical company derives a third of its revenue from sales of internationally sourced or produced products, with 30% of its total cost of goods sold (COGS) being international in origin (high tech and apparel have an even higher proportion, exceeding 80%).

This simultaneous combination of complexity and growing dependence suggests that many of the foundations of corporate finance will be increasingly called into question. The World Trade readers surveyed for this study identified three general areas of finance that require serious attention in order to optimize the benefits of global supply chains. Their recommendations included: 1) an expansion of the CFO's role in the organization; 2) increased automation of the physical and financial supply chain processes, and a better understanding of their interdependencies; and 3) more extensive use of trade finance services to ensure money and risk are being managed aggressively at all times.

Merging of physical and financial supply chains

CFOs, able to see the big-picture impact of business tradeoffs on strategic corporate objectives and financial performance, are in a unique position to lead the drive toward less risky and more effective trade processes. At the best-performing companies, the CFO is not merely running a back-office support function, but is leading the charge to creating cross-functional processes for global trade. At more than one-third of firms surveyed, finance is taking a leadership role.

CFOs who are succeeding in improving cash flow and helping their companies lower the cost of goods sold are linking together financial supply chain (the activities involved in planning and executing payments between trading partners through various financial instruments) and physical supply chain initiatives. “I'm looking to drive financial efficiencies through automation and increased visibility of order and payment status with our international vendors,” said the CFO at a mid-size apparel manufacturer. “But my hidden agenda is to leverage the same electronic trade backbone to create automation across my sourcing and logistics processes as well.” Similarly, a trade finance director at a large consumer goods company reports: “We're spearheading a vision of an end-to-end electronic environment with paperless transactions.”

One of the most exciting aspects of the merging of physical and financial supply chains is the ability to trigger settlement activities off a much richer set of milestone events. Today, a company might use a supplier's order acknowledgment or advanced shipment notice and a warehouse receipt from the company's distribution center as milestone triggers. However, once a firm establishes a backbone for physical supply chain visibility, that same backbone can be used to trigger payments against such events as automated manifest filing, arrival at consolidator, in-gate at port, loaded on vessel, vessel departure, arrival at destination port, customs clearance, arrival at deconsolidator, loaded on truck, etc.

The challenge of visibility

Best-in-class companies (defined in the study as the top 20% of performers) achieved a 15% or greater reduction in total cost of sourced goods since 2002 and report a cash-to-cash cycle of less than a month.

What's preventing more companies from achieving best-in-class performance for global trade? According to study participants, the biggest barriers are insufficient legacy technology support and a lack of visibility to projected cash flow, inventory, and hard and soft financial commitments. As global trade activity expands, it becomes more important for a company to create a fully visible, primarily paperless environment for transacting and monitoring orders with international customers and suppliers.

Less than a quarter of companies report having an automated financial process that extends to international vendors. In fact, 60% report that their international settlement process is still paper-based. Manual ordering and settlement processes lead to sporadic invoicing (some companies report a week up to a 60-day delay in receiving invoices from vendors, caused by manual batch invoice processes) and to a high percentage of disputed invoices, causing cash flow unpredictability.

Employing an electronic platform, on the other hand, results in multiple benefits. Executives are finding that driving purchase order, shipment, and payment automation helps them gain timely visibility into cash funding requirements. A divisional president who spearheaded a financial automation project reports: “Our Treasury group can now track purchase orders against expected and real shipment dates and thus do better cash planning.” The same electronic document and status information used by finance can be used to create an early-warning system about potential product delays for purchasing and logistics departments.

Beyond low cost sourcing

Companies frequently make two fundamental mistakes in their low-cost country sourcing decisions: 1) Their definition of total landed cost is incomplete, leaving out such vital elements as inventory carrying and obsolescence costs; customer service penalties from late shipments; freight accessorials (e.g., add-on costs like port or stop-off fees) and fuel surcharges; and full duties, taxes, and tariffs; 2) They fail to consider the revenue implications of longer and more unpredictable lead times, demand fluctuations, and supply uncertainty.

Even when true total landed costs are lowered, it does not mean that the most profitable sourcing decision has been made. Companies are finding that a rush to low-cost country sourcing can lead to:

• Profit erosion. Total landed cost may decrease but longer and more unpredictable lead times cause the company to hold more safety stock. This results in higher inventory-carrying costs and larger inventory write-offs from aged inventory when demand shortfalls occur, eroding corporate profitability.
• Missed profit maximization. Total landed cost may decrease but longer, more unpredictable lead times prevent the company from capturing upside demand and the associated profit.

Profit maximization requires a paradigm shift from a total landed cost to a total delivered profit mentality. Total delivered profit analysis enables a company to understand which percentage of which products should be sourced from short lead-time versus long lead-time locations to maximize profit. This is done by modeling the revenue implications of longer lead times, demand fluctuations, and supply uncertainty to create a global sourcing strategy that will truly maximize company profit.

Besides improving sourcing decisions, a total delivered profit mindset can be used to take early action to mitigate cost surprises that do arise. By tracking actual global sourcing costs for a product on an ongoing basis and comparing them with the target cost estimates, action can be taking to ensure margin is maintained. This includes changing product pricing and promotions or the mix of near-source and far-source activity. Similar actions can be taken to mitigate demand or supply surprises.

For a CFO, this provides a new level of control over the cost of goods sold and corporate profitability.

Technology investments

Given the complexity of international transactions, it's not surprising that companies are seeking help from external trade finance providers and technology vendors. Without automated processes and strong working capital and cash flow management, the more global selling and sourcing that's done, the more manpower will be required and the more unpredictable financial conditions will be.

• 35% of study participants have at least one budgeted project for financial management technology; another 31% have future plans to enhance these systems.
• 30% of companies have at least one budgeted project for trade compliance technology; another 38% have future plans to enhance these systems.
• 73% of companies plan to increase their use of trade services from financial institutions.

Leaders are investing in more technology. For each individual financial technology analyzed, best-in-class companies are roughly twice as likely as their peers to have currently budgeted projects. Companies are finding that legacy processes and spreadsheet-based systems are not up to the demands of global transactions and their associated banking interactions, foreign exchange requirements, and risk profiles. Moreover, without a system designed for international transactions, it can be challenging to understand the true cost of transactions and thus the real business unit or product line profitability.

Leading the way in current technology projects are initiatives to improve order, shipment, and inventory visibility. Fully 85% of companies have implemented or plan to implement visibility functionality. Understanding the status of trade transactions from procurement to payment, ideally through the use of executive dashboards and exception alerts, delivers a new level of cost and cash forecasting and control for financial organizations.

When asked which vendors they favor for order visibility, financial management, and trade compliance technology, respondents varied widely in their answers, depending on the size of their firm. Fully 50% prefer to do in-house development as well.

• Large companies are most likely to look first toward a trade compliance software or trade platform vendor (i.e., providing on-demand financial, compliance, or logistics management technology). ERP vendors ranked a strong second.
• Mid-size firms prefer to rely on technology from their logistics service providers.
• Small firms seek technology assistance from banks or other financial institutions.

Settlement management

The top growth areas for international settlement management are (1) credit card and purchasing card (P-card) support for international sales and (2) open accounts.

Of those companies that plan to use more letters of credit or documentary collections, almost all are mid-size and small companies. Letters of credit will continue to decline as a financial settlement method barring significant changes to letter of credit terms and conditions (such as widespread adoption of eUCP, the Uniform Customs and Practice for Documentary Credits for Electronic Presentation).

In some instances, there are compelling reasons to maintain letters of credit, such as a key supplier's unwillingness to do business any other way or the country risk being too significant to use other settlement methods. Even so, companies can still drive efficiencies through automating the preparation of letter-of-credit documents and automating the reconciliation with relevant logistics data and business documents. wt

Sidebar 1: Impressive Return on Five-Day Improvements in Accounts Receivable Balance

Based on Aberdeen's work with companies, we believe most enterprises can easily obtain five-day improvements in accounts receivables balances and five days of inventory reduction through basic steps such as moving to open accounts from letters of credit, factoring receivables, free trade agreement management, and reducing inventory investment via improved supplier and in-transit visibility.

What results will this produce?

A $1 billion company that imports one-third of its goods can free $6 million in cash from these types of improvements. Moving from paper-based to electronic invoicing and disbursement programs can extend days-payables outstanding by 15 to 20 days on average, freeing another $4 million to $5 million in cash. This means that the typical $1 billion company can free $10 million in cash by improving its basic trade processes.

A $1 billion company with 80% international sourcing and 80% internationally originated COGS can free $40 million in cash through these same initiatives. Freeing cash directly impacts the quality of a company's earnings, which impacts the company's price/earnings ratio and its market capitalization.

Sidebar 2: CFO Action Recommendation Key Takeaways

• Work towards a fully visible, primarily paperless environment for transacting, monitoring, and settling orders with international customers and suppliers.
• Create programs that enhance suppliers' fiscal health while lowering procurement costs for the enterprise.
• Use more services from financial institutions to lower transaction costs, smooth cash flow, and make it easier for international customers and suppliers to do business with your company.