Category Archives: Finance

Buyer Beware! A Tax Efficient Supply Chain is Not a Tax Effective Supply Chain!

Many global consultancies with large tax practices and some supply chain capability like to preach tax efficient supply chains and how they can help you optimize your global supply chain to minimize the overall tax that you pay. As many multinationals know all too well, sometimes the biggest cost after the product cost is not the logistics cost, but the tax. Depending on where you are buying from, where you are storing your goods, and where you intend to sell the goods, you can end up paying a plethora of taxes that can add up real fast.

The country you are buying from likely imposes federal and state taxes on all sales, and might even impose municipal taxes as well (especially if there is a value-added service component). Then you have to get those goods to a port (air or sea), and guess what, there will be taxes on the transportation. Then the dock or carrier likely charges a loading service fee, which is, of course, taxed. And let’s not forget the export duties. Ka-ching! And then there’s the air or sea transportation tax (as the carrier is registered somewhere). And, of course, landing/docking unloading fees when you get back to land. And then, Free/Foreign Trade Zone be damned, when you (finally want to) import those goods, import duties! Ka-ching! Then you have local transportation costs, taxed, and local warehouse costs, taxed, and even final transportation costs to the store or consumer, taxed again. Taxes. Taxes. Taxes. And if you have to pay all those taxes, you might as well just source from the closest factory because, regardless of how much more their unit cost is, we guarantee it will be cheaper.

However, if you have what the tax consultants call a tax efficient supply chain, then, because you are theoretically sourcing from countries you are not doing (much) business in (or selling in), then your organization is not responsible for most of these taxes, and the rest of the taxes, through clever classification and trade agreements, are minimized.

But just because you are not responsible for a tax doesn’t mean that you don’t have to pay the tax up front (and then file for reimbursement later). In many countries, unless you have an exemption id to provide the seller or [logistics, etc.] service provider (which may or may not exist or which might only be granted to non profits, etc.), the seller / service provider still has to collect the tax. And if it takes six, nine, or even twelve months to recover the tax, this is not exactly tax efficient.

First of all, your working capital is tied up, and there is a cost to having this tied up, which is the greater of what it costs you to borrow that working capital from your lender, the average early payment discount you are giving up, or the investment opportunity your Finance department has at its disposal (through factoring, short term GICs, etc.).

Secondly, there is a cost associated with the recovery of that tax. It will consist of at least the time required to submit the paperwork for recovery, and fees associated with submitting the paperwork for recovery, and, if the process is so involved or onerous that you really need a best-of-breed software solution to help you, the cost of that solution. (Note that you might need multiple such solutions, as many as one for each country you have to to through a submission process as some countries might only certify in-country vendors to connect to their e-document submission systems or accept, without [mandatory] audit, documents produced by an in-country provider.)

Third, and most important, the supply chain is not cost efficient if the cost of minimizing the tax ends up creating a considerably more dispersed supply chain that ends up significantly increasing the logistics cost, and, as an effect, the overall cost. Tax efficiency is supposed to minimize overall cost and cannot always be considered on its own.

In other words, unless the consultant creates a model that takes all of this into account (and many don’t due to the overall complexity of such a model), the “tax efficient” supply chain is not a “tax effective” supply chain and is not necessarily one you want to pursue.

Oversight for more than just your Travel & Expense budget management

Oversight is an Atlanta-based software (as a service) company founded back in 2003 to help organizations monitor spending in an effort to identify errors, waste, misuse, and fraud in the grey area of enterprise spend. As every recovery firm will tell you, the average organization will overspend by 1% to 3% as a result of over billings, duplicate billings, unnecessary spend on superfluous demand, maverick spend, and even fraud. (And they make their living recovering a portion of that, typically a third, and then charging you 33% of the recovery as their fee. Sounds small, but 1/3 of 1/3 of 3% of spend is 0.33% of spend, and if the organization spends 100 Million, they get 330,000 for an effort that can be largely automated and, even worse, be avoided with proper up-front spend monitoring.)

For example, if all invoices are compared to invoices and goods receipts before payments are authorized, this can prevent overpayments. Duplicate billings can be identified in the same way (and duplicate payments prevented). Potential fraud can be identified by forcing all invoices from unknown suppliers, for unknown products, or for unexpected amounts to be manually reviewed. (This can’t prevent in-house fraud, where a buyer pays a fake invoice to a fake company controlled by a relative, or a co-conspirator, but it can prevent external fraud.) Unnecessary spend on superfluous demand will require up front requisition control, as will maverick spend, but at least there will be no overspend or duplicate spend that can be unrecoverable once the contract with the supplier expires.

Oversight is unique in that it is not so much a software platform but an insights platform. Employing a team of data scientists focussed on identifying new algorithms and techniques for fraud detection, Oversight uses their in-depth knowledge of fraud to build solutions that will help the clients identify potential cases of fraud that they could never hope to identify on their own. The best most companies can do is sample based audits and spot checks which are unlikely to identify much fraud as these will generally only be on a few percentage of invoices or transactions, and most employees who have been getting away with fraud for a while will not be doing anything obvious, and the fraud will not be detected without correlations across documents and systems. That’s where Oversight comes in.

The Oversight solution is a web-based software solution for automatic spend analysis and identification of high-risk or potentially fraudulent transactions that comprehensively analyzes T&E, purchase card, and accounts payable spend using a suite of statistical, clustering, data mining, break point, rule-based, evidentiary reasoning, and machine learning algorithms that look for discrepancies, suspicious patterns, known fraud, and risk indicators to identify those transactions that need to be manually reviewed. The dashboard-driven, or work-bench driven, interface allows an analyst to drill into suspicious transactions by country, organizational unit, risk level, or exception type and can be configured to show the analyst only those exceptions assigned to her, or her team, or every unresolved exception in the system.

When a user drills in by exception type, she sees an overview of the overall risks by country and can drill into suppliers to see the specific exceptions. When a user drills in by country, she can see the overall risk by supplier and then by exception. In other words, she can drill into at-risk transactions using country, organizational unit, supplier, and at-risk type in any manner they please.

Or, they can look for exceptions by process. Right now, Oversight supports the identification of at-risk transactions in the travel & expense, procure to pay, and purchase card processes and has recently added support for FCPA, Anti-Bribery, and Corruption Risk — including the identification of known politically exposed parties.

Plus, the platform not only integrates with all of the big supplier and financial data providers — such as Dunn & Bradstreet, Bureau van Dijk, and CreditSafe — but also integrates with providers of risk indicator data such as Ecovadis and Sedex Global. Plus, they maintain their own databases of known politically connected parties, gentlemen’s clubs, denied parties, and other parties that an organization typically should not be allocating funds to. This last capability is quite important … just ask American Express which once received a 241K strip club bill authorized by the CEO. (Source)

Since fraud attempts differ by country, and collusion is hard to detect with a standard m-way match invoice processing platform, Oversight brings a powerful offering to the expense management space. It’s a platform worth checking out. For a deeper dive into the platform, check out the recent coverage by the doctor and the prophet over on Spend Matters Pro [membership required]. (Part I is up with Parts II and III coming within a week.)

A Financial Health Check Should Be a Pre-Qualification of Every Supplier Qualification

And every organization should review a financial health or risk report, comprised of, or augmented with, third party data, and, unless they are (or have in-house) financial experts, this should preferably be done by a third party. The reality is that in today’s data driven world, no organization should be surprised by a bankruptcy of a mid-size or larger supplier that has been in business for at least three years. The probability of the vast majority of these bankruptcies are now predictable by financial analysts and while they may get a few wrong (as some companies may shape up just in time and others may fail faster than expected for a non-financial reason), they get a lot right.

And it’s not like financial ratings are hard to get anymore. While they are not as insightful, as they work exclusively on credit data and stock data compared to released financial statements (which is where the early warning indicators hide), most of the big data / credit services track enough data to come up with a reasonable financial risk score that at least lets you know whether, from a financial perspective, the supplier could be reasonably safe or is currently very risky — and needs a detailed analysis. Moreover, a financial health-focused offering by RapidRatings, and their FHR (Financial Health Rating) Report (which has been around for almost a decade), with an open example here, provides not only deep insight into potential risk, but the magnitude of the risk and the hard data for the risk — as well as the insights — and can detect risks from early warning signs that have not yet manifested in observable behavior (such as late payments).  In addition, RapidRatings’ new Financial Dialogue offering, which works in conjunction with the FHR, identifies the most important questions you should be asking your suppliers based on their health rating.  (An when you look at just the FHR report, you wonder why every organization is not doing at least this detailed level of supplier financial health analysis before committing a large or strategic spend to a supplier when all the data they need can be summarized in an easy to understand fashion.)

Now, you might say that because only one vendor, today, offers this depth of a report, which wasn’t previously available, and because the organization has done just fine without it for almost a decade, that you don’t need it, but SI would like to disagree. With global sourcing constituting so much of your supply chain, you don’t really know that much about your suppliers, their health, or the conditions in which they operate. And if they are supplying a custom made component, a raw material in limited supply, or a specialized service, the cost of recovery could be much greater than the initial cost of supply. These reports are becoming a necessity as part of your risk management.

SI is not saying you have to use RapidRatings or subscribe to their FHR reports (although they should be on your shortlist), but that you should at least do deep financial analysis on all of your strategic suppliers and use a platform to do it.  And while SI expects that other vendors with the same degree of analytic capability, financial know-how, and supplier insight — specifically Resilinc, FusionOps, and Simfoni — will soon attempt to release similar offerings, with their own unique spin, SI doubts that these other providers will be able to match the depth provided by RapidRatings for quite some time, as they are, respectively, focused on supply chain resilience, big data insights, and analytics on the go.  (However, if you are  currently using any of these vendors, you should work with them on their new analytic offerings as they can still offer other insights into the suitability of the supplier for your operation, assuming the supplier is financially viable enough to work with in the first place.)

While financial risk or financial health is only one KPI that should be used to analyze suppliers before qualifying them for inclusion in an event, it is an important one — the organization needs a supplier that will stay in business. Another KPI that should be included is a comprehensive CSR (Corporate Social Responsibility) assessment, as you want responsible and sustainable suppliers, and this can be obtained as well from vendors such as Sedex Global and Ecovadis. Finally, once the supplier has been deemed financially stable and sufficiently responsible, an overall supply chain risk rating should be computed (based on geography, risk of natural disaster, political interference, etc.). This will require either a risk management vendor (such as Resilinc, Risk Methods, etc.) or an analytics vendor that pulls in feeds from one of these vendors.

It’s a lot, but if you can be sure in your supplier, that’s one less worry in your overly complex supply chain.

If AP is the Tax Department, Make Sure They Optimize Tax Recovery!

A recent guest post on spend matters that called Accounts Payable: The New Tax Department noted that as governments worldwide continue the fight against tax fraud, they are requiring more data from enterprises, even down to the individual invoice level.

The guest post also notes that VAT/GST payers often find these requirements onerous, as they can delay operations and increase processing costs for individual transactions, but it doesn’t have to be this way.

An appropriate software platform that supports both customer e-Invoicing from invoices that originate from the organization and customer paper invoicing and also supports the tracking of each tax collected (against an appropriate tax code) can make the identification, consolidation, and submission of such invoices a snap (as long as it supports the required output data format). One click can generate the “tax package” for a country of choice and a simple upload to the government site can send it on its way. It doesn’t have to be hard.

And even if your organization does not have to do this today, it should plan for it, especially if it wants to go international. Currently, as per the post, 16 countries require individual tax invoices and the number is growing. Moreover, many countries can ask for them at any time and an inability to produce quickly can land you in very hot water.

But even more important than tax payment is tax reclamation. If you have a really good platform, it will allow you to import the invoices you receive from your suppliers, track the tax you pay by tax code, and automatically calculate tax owed to you (as you pay tax you collect and get reimbursed for tax you pay in many countries) as well as the supporting tax package (if required). Remember, the governments typically only care about getting their share and the invoice submission laws are all about making sure you pay what you’re supposed to, not about making sure you get credit for what you pay.

Now, if you are operating in a dozen countries, it will be up to legal and finance to figure out which ones you have to collect in, report in, and what taxes and reports are relevant, and this will generally be beyond the capability of most e-Procurement and AP programs, but the necessary data:

  • standard tax code id
  • UNSPSC and/or HTS code
  • collected / paid
  • amount
  • date
  • etc.

as well as the required data formats (EDI, XML, etc.), and one-click import/export (for a standard date range) are easy to support — and any good e-Procurement platform should support it (and if it doesn’t, it’s not a platform for you). And you need one of these, so you can get the AP department what they need to not only make governments and suppliers happy, but make sure you reclaim every penny of tax globally you are required to. Taxes add up … fast … when not reclaimed. So make sure your Procurement platform does what it needs to do to support your reclamation.

The Death of Factoring Will Be Highly Exaggerated

Last Friday, Spend Matters published a great Friday rant by the prophet aptly titled Die Factoring, Die! because Factoring can be the death of many an uninformed supplier who, like desperate individuals, take out payday loans to pay off payday loans at insanely compounding interest rates until they go bankrupt.

Factoring should die. It is no longer needed, but the doctor fears just like the pulp industry has survived for over a century when it should have died out long ago, it will still be around a century later. Just like the pulp industry had the perfect environment to grow until it was big and powerful enough to effectively outlaw the competition, the factoring industry has the same perfect environment to grow and crush the better options.

Before we explain, we’ll point out that just like there is a better alternative to factoring, as the prophet pointed out in his post, there is a better alternative to wood-based paper. In particular, the alternative that was around before the wood-based paper craze: hemp. Whereas hardwood trees take decades to mature, hemp can be grown and harvested in a single growing season. It’s the number one biomass producer on the planet (10 tons per acre in 4 months) and contains 77% cellulose (needed for paper) compared to the average tree at 30%. It’s stronger, the paper lasts centuries longer, does not require any bleaching, and the production requires significantly less water and energy than paper production from trees. (The pulp and paper industry uses more water to produce one ton of product than any other industry and is the fifth largest consumer of energy on the planet.) Hemp for paper is many order of magnitudes better, but since hemp (which contains, on average, 1/5 to 1/10th the THC of cannabis) was made illegal with the delegalization of THC in North America, it’s not an option.

This was possible because the pulp and paper industry was rich and powerful enough to lobby for the delegalization across the board, vs. just the delegalization of cannabis. They got that way because, during the start of the industrial revolution, when paper was needed en-masse to “power” back offices, North America was filled with old hardwood forests and there was not much hemp, as hemp was native to Central and South America. The population was much smaller than it is now, the possibility of deforestation was not even considered (as manual logging could only go so fast), and the technology to produce paper from pulp was understood and easy (at the time). And it could meet demand fast — logging could happen year round whereas hemp could only be harvested once a year in many of the central and northern parts of the US. So it became the defacto paper producing industry, and since everyone needed paper, it obtained a monopoly. And since no one knew better, or was even allowed to learn of a better way, the monopoly persists until this day.

Similarly, the factoring industry has obtained a monopoly on what is effectively “payday lending” to suppliers that need money now, can’t get it from the bank, and don’t want to beg the local “godfather” for a loan (at interest rates that put even North American credit card companies to shame, with default penalties much worse than repossession). How did it get like this? First of all, there have been no other viable options for many of these suppliers (as not all suppliers are lucky enough to get buyers that will offer the [slightly] better alternative of early payment discounting, as not all buyers can afford that). Secondly, growth demands working capital, and the capital has to come from wherever it can, and if you are a supplier in an emerging or tight market, it’s often factoring or death. Thirdly, the banks stayed out of it for too long, allowing the industry to grow and cement on its own, and now that it is “proven”, the banks have been drawn to it like moths to a flame, and they control the global cash flow.

So as long as it is effectively a cash cow, which it is as it is a slow cash drain (death) for most suppliers (meaning that you’ll acquire and keep more customers in a year than you bankrupt), more suppliers need it everyday (as they try to stay in business when times become troubled or they try to grow faster than they can afford), and it’s relatively low risk compared to other types of lending, it’s going to continue to gain support and traction from the lenders, who are going to do their best to present it as the only option available. And some suppliers will believe, lock-in, and get trapped in the factor cycle, factoring more and more invoices over time until every invoice needs to be factored as soon as it is issued just so the supplier can make payroll.

So even though modern platforms, backed by “big data” (even though the data doesn’t have to be all that “big” to adequately calculate risk and buyer payment time-frames), and enabled by networks (that give the supplier dozens or hundreds of options including half a dozen or dozens of better ones), could provide better options, the doctor just doesn’t see it happening any time soon. We’ve known since 2000 that multi-line item optimization can save an organization 10% or more on just about every sourcing event (and since Aberdeen’s advanced sourcing study in 2005 that it will save an organization an average of 12% across all categories) and still less than 10% of organizations using strategic sourcing platforms are effectively employing it — even though modern optimization-backed sourcing platforms make it easy enough for even junior buyers to use it self-serve and run basic models and identify considerable savings without expert support. (Not always the full 10% to 12%, but enough savings to justify its use on each and every event!) Factoring is finance, and banks have made finance unnecessarily complicated to maintain the monopoly. So it’s here to stay. And when big data and networks enter the picture, you can bet it will be the factorers, and not the factorees, that gain.

It’s sad, but for now — and the foreseeable future, it’s true.