Dear colleagues,
As we have commented in previous articles, we are entering a phase of systemic change, characterized by the scarcity of capital.
On the one hand, the economic system bears the largest debt in history. Debt consumes capital and excess debt over-consumes capital
On the other hand, the scarcity of resources (fundamentally energy but not only energy) is weakening growth and slowing down the generation of capital.
If capital is overconsumed by excess debt and not regenerated at the same rate by weak growth, capital becomes scarce. And capital is the most important resource of the financial system. It is not by chance that the current socio-economic system is called capitalism.
When the most critical resource becomes scarce, the priority is to optimize it. Thus, if capital is the most critical resource of the economic system and it has become scarce, the priority that drives the systemic transformation that we are experiencing is Capital Optimization.
We already observed symptoms of the overconsumption of capital and its future scarcity during the Financial Crisis of 2008. But for better or for worse, the ultra-expansionary monetary policies of central banks in the last decade have flattened the yield curve, delaying the problem. But in doing so, they have stimulated the consumption of capital, exacerbating the problem.
The disruptions to supply chains that followed the COVID-19 pandemic lockdowns and the military standoff in Ukraine have triggered volatility in energy prices, which have been transmitted throughout the economy, as an indicator of the capital shortage of the system.
As an example of this volatility, you can check the freight price in the Freightos Baltic Index (FBX) - Global Container Freight Index between September 2020 and December 2022.
http://fbx.freightos.com/
Optimizing a critical resource in a system requires synchronizing its constituent elements by exchanging information between them. In physical terms, reducing the entropy of the system. This is a well-known principle in Physics, from classical thermodynamics to the most recent proposals in quantum information theory.
But since I imagine that most of the readers are not familiar with the Laws of Physics, I will try to explain it with an example of a process managed with an SAP system.
Suppose that a US company is selling personal computers to a French company and the order is valued in EUR.
As we know, the USA company will be subject to an exchange rate risk due to the volatility of the EUR and the USD.
But let's look at the process in more detail; The exposure to exchange rate risk will begin at the time of order confirmation (t=0) and it will end at the time of payment (t=Tpayment).
If at that time the company signed a purchase-sale contract with a broker, through which it sells the EUR that it will receive from its French client at a fixed exchange rate, receiving USD, with the date of purchase of the currency t=Tpayment (date of payment of the computers order), the company would have hedged against the risk of volatility between the exchange rate of the EUR and the USD.
Contractually the Payment Date (t=Tpayment) is always referenced to the Invoice Date (Tpayment = Invoice Date + Payment Term) and the Invoice Date is referenced by contract to the Delivery Date (Delivery Date +/- Billing Calendars, etc.)
The difficulty for the selling company is that it cannot know the exact Delivery Date because it is subject to logistical constraints and transportation capacities and disruptions. And without a deterministic Delivery date, the selling company does not have a deterministic Payment Date of the French customer.
In summary, the problem of optimizing capital in exchange rate risk exposures and hedges is limited to accurately estimating the Delivery Date of the order. As you can see, and contrary to what the initial perception tells us, this is not a banking or financial problem, it is a fundamentally logistical problem.
SAP Sales and Distribution consultants know that system integration provides us with powerful tools to estimate the Delivery Date.
The first of these is the Available to Promise availability check. If the vendor has this functionality configured, the system will validate the company's ability to meet the Requested Delivery Date based on confirmed stock entries and exits, safety stock, etc.
The Delivery Date also depends on the transportation time and this can be estimated by the route that links the shipping point with the ship-to party. The handling time which can be estimated with the parameters of the shipping point, etc.
As we can see, the more logistical constraints our SAP shipping system considers, the more precise the estimate of the Delivery Date will be and, therefore, the more precise the estimate of the exchange rate risk exposure will be and consequently the more precise the hedging will be. This synchronization between the logistic and financial processes reduces the entropy of the system and makes it possible to optimize capital.
As we know, the logistics reality is even more complex. From the moment of confirming the order until the execution of the expedition, we will find that other clients will cancel orders with the same materials, production or supply will be delayed or accelerated on the planned dates, etc. To manage these disturbances, we will execute the back-order processes that will adapt to the new supply and demand situation, providing new expected Delivery Dates, with new order confirmations that will be converted into new expected Payment Dates and reestimation of forex risk exposures and risk hedging instruments.
Once again, it will be the management of logistical constraints and the precise estimation of the Delivery Date that will allow us to optimize capital effectively.
And although it is not my intention to make this blog much longer, I am going to mention that logistics have come a long way in the last 30 years. For example, with S4 HANA we have the New Product allocation (PAL) features in Advanced ATP, the integration of Product Allocations with the consensus forecast in IBP-Demand Planning, the management of supply restrictions, supply, transportation in Integrated Business Planning Time Series and Order Based, Transportation Planning with SAP Transportation Management, geolocation and many other features that offer us more precise estimates of the Delivery Date, and therefore more accurate estimations of the Payment Date.
By integrating the logistic processes with the hedging processes of exchange rate risk exposures, we are synchronizing the logistic and financial processes, reducing the entropy of the system and the consumption of capital.
And as I said at the beginning, in a scenario of scarcity of capital, the priority is to optimize it and that is the structural environment in which the world economy finds itself.
This article only showed one example, selected for being more intuitive, but the principle of synchronizing the financial and logistics arm of the value chain for reducing the entropy of the system is also the basis for optimizing capital in more complex capital and liquidity allocation processes.
These are the guidelines followed by our team in the construction of our Capital Optimization system, built on top of the SAP Integrated Financial and Risk Architecture.
Our Capital Optimization system “speaks” with the business processes of our clients' SAP Systems (70% of the world’s GDP) translating them in terms of Capital and Liquidity generation and consumption. With this information the Capital Optimization system measures the deficits and surpluses of capital and liquidity of the business processes and proposes financial instruments to offset these deficits and surpluses, optimizing the consumption of capital and liquidity of the system.
We are working on presenting our system to the market and looking for business partners and investors.
If you are interested, do not hesitate to contact me at ferran.frances@capitency.com
I look forward to reading your comments.
Kindest Regards,
Ferran Frances.
www.capitency.com
Join the SAP Banking Group at: https://www.linkedin.com/groups/92860
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