Supply Chain Finance – How it works and is it right for you? [Part 1]

The phrase ‘supply chain finance’ can be used as a general description of all transactions within the realm of trade finance, or as a specific label from a particular kind of arrangement between suppliers and buyers. In this article we will concentrate on the latter.

What is supply chain finance?

In a simple supply chain, goods flow from supplier to manufacturer, to distributor, to end customer. Conversely, cash flows back up the chain from the end customer to the supplier.

Supply chain finance (also known as ‘reverse factoring’) refers to shared online accounts that are offered by financial institutions to enable buyers and suppliers to manage their invoice payment terms, maintain liquidity and keep cash moving freely through a supply chain.

In supply chain finance, funding arrangements are often initiated by buyers, particularly when they are larger and have better credit ratings than suppliers who may well be small businesses in emerging countries. It typically evolves in trading relationships where suppliers and buyers have a solid trade history.

What is invoice factoring? And how is it different?

In contrast, invoice factoring is often initiated by suppliers and refers to a process in which suppliers sell their unpaid invoices to a third party (a ‘factoring company’) in exchange for immediate funds which they can invest elsewhere. They may do this to maintain liquidity or to remove the risk of non-payment with new buyers. Invoice factoring often happens in new trading relationships where suppliers and buyers have no history.

How does supply chain finance work?

Traditionally, in overseas trade, suppliers (exporters) encourage buyers (importers) to purchase goods by offering credit in the form of deferred payments. That is, goods are shipped but buyers are not asked to make payment for them until 30, 60 or 90 days later. This can create cash flow pressures for suppliers, particularly smaller companies without easy access to bank credit.

Supply chain finance offers a way to ease those cash flow pressures.

Typically, supply chain finance works in the following way:

Buyers and suppliers conduct business within a shared online account set up by a financial institution. This account gives control of invoices and payment dates to both parties.

Once buyers have approved an invoice, an early payment option is made available to them. As its name suggests, this offers the benefit of a discount on the total cost if they pay earlier than the due date. Suppliers can also opt to take early payment on some invoices.

This arrangement benefits both parties: buyers can get the goods at discount while suppliers can get funds earlier than arranged. This increases working capital and allows both parties to invest in other areas to boost growth. It’s a mutually beneficial arrangement that secures the flow of trade in the supply chain.

Finance charges will vary according to the dates of payment chosen by the supplier. Within the above framework, suppliers are given the flexibility of dictating payment terms and selecting exactly which of their total invoices they want funded at any given time. Buyers may also seek to extend payment terms if it benefits their cash flow, meaning they can defer payment without negatively impacting their suppliers. It’s the financing institution that will bear the load, not the supplier. And since funds are advanced based on the buyer’s promise to pay, rates for that finance are based on the buyer’s risk, not the supplier’s.

Stenn International Ltd. 21 March 2022.
Source: Stenn International Ltd, https://stenn.com/blog/articles/supply-chain-finance-factoring-explained, 18 September 2022.

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