Last Updated on September 22, 2021 by Guest
Supply chain finance has become a prevalent concept recently because it allows companies to boost their working capital, create stronger supplier relationships and minimize chain risk. So, what is so special about this idea that has proven to be so popular?
Let’s start by defining the term. Supply chain finance (SFC), a.k.a. reverse factoring, is a way of offering your suppliers early payment in the form of a third-party-funded solution. What is unique is that, unlike other forms of receivables financing, the cost of funding for suppliers using supply chain finance is based on your credit rating rather than theirs. This means that your suppliers will receive funding at a more favorable rate than they can achieve independently.
Also, SFC is sometimes used as an umbrella term to include other types of early payment programs, such as dynamic discounting, a self-funded solution in which buyers offer suppliers early payment in exchange for a discount. Supply chain finance, on the other hand, is funded by third-party finance providers.
How does SCF work?
Every supply chain finance program is different, but most of them usually include the following steps:
The supplier uploads an invoice onto the SCF platform. Then, the buyer approves the invoice for payment. Next, the supplier selects chosen invoices for early payment via SCF. After that, the supplier receives payment straight away, with a small fee deducted. Finally, the buyer pays the funder in full on the invoice due date.
The differences between various models in the market may not be so significant. Still, it’s essential to know that SCF includes both bank-run programs and multi-funder solutions run by technology vendors. Some allow you to choose from a variety of different funding solutions and, thus, avoid the risk of funding concentration. Some, such as the easy-to-use Trade Finance, also offer payments in a range of international currencies.
Benefits for buyers
Buyers typically want to extend their days payables outstanding (DPO), while suppliers wish to receive a payment as soon as possible, i.e., to reduce their day’s sales outstanding (DSO). This conflict is resolved by suppliers receiving payments early and buyers paying later on the invoice due date.
If you’re a buyer, you improve your working capital position in this way through longer payment terms and a better cash conversion cycle. Also, you reduce supply chain risk by supporting your suppliers with affordable financing and reducing the risk of disruption to your supply chain.
This is accompanied by strengthening supplier relationships since helping them improve their working capital is a powerful tool in building stronger relationships. You also gain an advantage in negotiations because your procurement team may be able to negotiate better commercial terms if they offer suppliers SCF. Last but not least, opting for this option supports business growth.
Namely, SFC puts your supply chain in a better position to accommodate an increase in business and help your suppliers invest in R&D, which might also benefit your business.
Benefits for suppliers
Suppliers can also reap benefits offered by SCF – from DSO improvements to access to low-cost funding – all without affecting their existing credit lines. With an early payment, suppliers can reduce their DSO and thus boost their working capital. Also, there is a lower cost of funding since SFC, unlike other forms of receivables funding, is based on the buyer’s credit rating. This means that the supplier’s cost of financing is lower than for solutions such as factoring.
Next, suppliers can expect an improved cash flow, which will allow them to be in a better position to expand their businesses and allocate more funds to innovations. Similarly, the concept facilitates better cash flow forecasting since it includes greater certainty over the timings of payments. This allows suppliers to forecast their cash flow better and make better-informed business decisions.
Finally, SCF provides access to a user-friendly platform since SCF programs use sophisticated technology that gives suppliers complete visibility over the payment process, increasing their operational efficiency.
As you can see, there are quite a few benefits to both suppliers and buyers when it comes to using supply chain finance, which is why it’s not surprising that this concept has been widely accepted and used. If managed properly, it allows everyone involved in a transaction to strengthen their respective positions, improve their working capital and, possibly most importantly, build strong relationships, which ultimately lead to supporting the whole supply chain. Also, if the past is anything to consider, one of the crucial supply chain tips is keeping it smooth and effective.