Supply chain financing (SCF) or ‘reverse factoring’ can be an incredibly beneficial financial technique for both buyer and supplier. It can help optimise capital for both parties and add greater security should the supply chain be disrupted.
But how exactly does it work and what should business owners look for in a potential supply chain finance partner? More to the point, is it a worthwhile endeavour for you and your business?
To answer these questions and more, keep reading.
What Is Supply Chain Finance?
Supply chain finance is the buyer-initiated process of utilising a third party finance provider to insure both supplier and buyer against possible supply chain disruption while optimising capital.
A form of cash advance not too dissimilar to invoice finance and dynamic discounting, fully functioning supply chain finance sees suppliers receive early access to capital should they deem early payment beneficial.
Under such circumstances, the third-party finance provider will cover the buyer’s invoice in exchange for a small discount from the supplier. Thereafter, the buyer pays the finance provider back at a later date.
However, through this type of financial arrangement, a buyer is able to lengthen their payment terms and retain capital while the supplier also secures working capital early. As such, it is a mutually beneficial financial arrangement.
More broadly, supply chain finance is also an umbrella term used to denote the practices employed by banks and other financial organisations to help secure the capital invested in the supply chain, thus limiting the risk involved.
Types of Supply Chain Finance
Supply chain finance is just one of many cash advance programs available for businesses and financial institutions. However, as stated above, it is often used as an umbrella term for other cash-advance payment terms.
- Dynamic discounting
- Invoice finance
- Trade finance
How Can I Get Supply Chain Finance?
It’s possible to arrange supply chain finance programs through UK banks, single-funded finance providers and through dedicated online platforms that are funded by multiple investors. However, it’s worth noting that securing supply chain finance with single-funded financiers carries an inherent risk as they tend to require non-committal parameters written into the agreement.
Similarly, while arranging supply chain finance programs with high street banks can provide an attractive arrangement, market fluctuations and ever-changing policies can also have a negative impact on the security and value of the chain.
With that in mind, if you’d like to discuss how and where you can get the best supply chain finance payment terms for your business, we recommend speaking to one of the Business Financing experts.
To do so, simply complete this online form and they’ll help to guide you through the process.
How long does it take to secure supply chain finance?
Typically, it takes between 30 – 60 days to establish a supply chain financing program. That being said, the pace of the process does depend on both the buyer’s available capital and the synchronicity of all three parties involved (buyer, supplier, third party finance provider).
How Does Supply Chain Finance Work?
Supply Chain Finance
Supply chain finance can be initiated when a buyer makes an agreement with an external finance provider.
Following this agreement, the buyer will approach their chosen suppliers with a view to entering a mutually beneficial, three-way agreement. Once this chain has be been established, the buyer may make a purchase from the supplier and, should the supplier see fit, they may request early payment on said purchases.
In plainer terms:
- The buyer makes a purchase from the supplier
- The supplier issues the purchase invoice to the buyer with a specified payment term (e.g 30 days)
- The buyer approves the invoice
- The supplier requests early payment on the invoice
- The third-party financer pays the invoice early (minus a small fee) on the buyer’s behalf
- The buyer repays the financer upon a new due date negotiated privately
An example of supply chain finance
With that in mind, let’s insert the process into a hypothetical Supply Chain Finance scenario.
If a farming business purchases fertilizer from a supplier, and the supplier wants to receive payment faster than the payment term that is stated on the invoice, or if the farm can’t yet front the cost/prefers to retain the capital for the time being, the supply chain finance can be utilised.
At this juncture, if the buyer approves, the third-party finance provider would step in and pay the invoice immediately on the farm’s behalf before establishing a new, extended payment term with the farm. For example, 60 days.
This enables the arable farming business to retain its working capital for longer while ensuring that the fertilizer supplier receives payment sooner, thus appeasing both parties.
What Can Supply Chain Finance Be Used for?
In general terms, supply chain finance can be used for any mid-large scale financial supply chain where such arrangement is of mutual benefit to both the buyer and provider.
That is to say, from small business start-ups to multi-national conglomerates, if the scale of purchase is large enough, supply chain finance can be used by buyers and suppliers in all industries to optimise capital and lower interest rates and overall costs.
Who Should Consider Using Supply Chain Finance
Companies and business owners in a multitude of sectors should consider applying for a supply chain finance programme. More to the point, as it is mutually beneficial for both buyers and suppliers, businesses on either end of the supply should consider entering such an agreement if the opportunity arises.
In particular, businesses that make or supply large-scale, regular purchases of goods or services will benefit greatly from the lower financing costs that supply chain finance can offer.
How Much Does Supply Chain Finance Cost?
The cost of supply chain finance is subjective to the specific parties, markets and goods/services involved. As such, it isn’t possible to provide a definitive cost without having first spoken to you and your potential supply chain partners.
That being said, due to the security provided by supply chain finance programs, interest rates and fees can be greatly reduced. Furthermore, the buyer will not incur any additional fees should the repayment period be extended as part of the agreement as supply chain finance solutions are mutually beneficial for all parties.
Likewise, the only cost for suppliers is that they are required to provide a small discount to receive early payment.
The Pros and Cons of Supply Chain Finance
- Increased market stability
- Access to global supply chains
- Optimised capital for both sides
- Lower interest rates and overall costs
- Extended payment terms for buyers
- Symbiotic relationships between trading partners can yield increasingly beneficial payment terms
- Can provide small-medium businesses with access to the global supply chain
- The introduction of third-party supplier finance carries its own risks
- Suppliers must provide a discount to release cash flow early
- If your third-party financial institution is affected by global markets, the agreement may be inconsistent
How Can Suppliers and Buyers Benefit From Supply Chain Finance?
Benefits for suppliers:
- Receiving earlier payment: reduces Days Sales Outstanding (DSO) encouraging improvements in capital.
- Reduced financial risk: payments are guaranteed by the third party finance provider
- Reduces financing costs: funding costs are traditionally lower for suppliers involved in a Supply Chain Finance program
- Improves cash flow forecasting: SCF provides suppliers with greater certainty over the arrival of capital.
Benefits for buyers:
- Allows buyers to buy in bulk: ultimately receiving a lower-cost for goods/services
- Maintaining a good relationship with their supplier(s): lower-cost funding maintains and improves buyer-supplier relationships
- Maintaining a healthy balance sheet: by improving their working capital position
- Subscribing to complex end-to-end supply chains: strengthen supply chains
Can I Get Supply Chain Finance If I Have Bad Credit?
Buyers with a bad credit history will struggle to secure supply chain finance as the arrangement hinges on the buyer’s credit rating.
That is to say, buyers with poor credit will not be able to secure a third party finance provider who is willing to offer up the capital in their stead as repayment may not be guaranteed.
Who Offers Supply Chain Finance?
There are a number of financial institutions that offer Supply Chain Finance. In the UK, these include banks, multi-funded online platforms and other single-funded financiers.
Ultimately, when entering into supply chain finance, who or whatever institution you choose to provide third-party supplier finance must be a stable, committed and reliable partner. As we mentioned earlier in the article, unstable or non-commital supplier finance providers can cause your supply chain finance solution to break down.
Entering into supply chain finance can be a fantastic way to optimise capital for both buyers and suppliers. However, it is critical that all members of the agreement remain committed to the smooth orchestration of the finance chain.
With that in mind, for buyers looking to establish a supply chain finance solution, it’s important to explore the market to establish precisely which suppliers and third party finance providers offer the best opportunity for their business.
With the aid of the Business Financing team, you can do just that. We have access to hundreds of supply chain financers and vast experience arranging highly successful SCF agreements.
What is the difference between dynamic discounting and supply chain finance?
Dynamic discounting is almost identical to supply chain finance save for one major difference; Dynamic discounting does not involve the use of a third party finance provider.
Instead, dynamic discounting sees a buyer give their supplier access to their surplus cash flow. As such, when the buyer makes a purchase and the supplier requires early payment, the buyer pays the capital from a pool of surplus funding.
Crucially, the buyer receives a discount in exchange for early payment and moreover, the earlier the payment, the greater the discount. Hence, dynamic discount provides a beneficial, risk-free return on a buyer’s surplus capital.
What is flexible funding?
Flexible funding describes the financial technique that buyers may employ whereby they utilise both dynamic discounting and supply chain finance at will.
This combined programme is often used by businesses that have surplus capital available for finite periods of time. During such periods, they would use dynamic discounting to secure valuable savings with the aid of their surplus capital.
Likewise, at other times of the year, when their surplus capital is needed elsewhere, they will utilise supply chain finance to secure risk-free purchases and optimise their capital. This seamless switching between the two programmes is known as flexible funding.
What is the difference between supply chain finance and trade finance?
While supply chain finance intends to secure a mutually beneficial financial agreement between buyer and seller, trade finance (TF) involves a more competitive transactional relationship between the two parties.
Moreover, TF is designed to reduce the risks presented by the buyer and supplier rather than the supply chain itself. For example, for a buyer, the risks include factors such as goods or services not meeting expectations while suppliers risk not receiving payment on the agreed terms.
Hence, through TF, trading partners may seek to mitigate the risks by applying different trade transaction structures. These include letters of credit and open account structuring.
What type of security do I need for supply chain finance?
Supply chain finance concerns the exchange of goods/services and working capital.
As such, any transactional process that involves a cash flow and, indeed, third-party financing, requires financial security. Hence, any supply chain finance program should be maintained as a closed system.
Moreover, it is advisable to secure fixed terms within the agreement to avoid unwarranted fluctuations and price spikes.