Everything You Need to Know About Supply Chain Finance
As supply chains stretch across the globe, there's growing pressure to free up cash that's often stuck in the process. For example, in 2021, around $523 billion was estimated to be tied up in the supply chains of S&P 1500 companies.
Both buyers and suppliers need working capital to keep things running smoothly. Supply chain finance, also known as reverse factoring, can help by ensuring a steady flow of cash. This approach helps businesses manage their finances better and adapt quickly to changes, making operations more efficient and responsive.
What is Supply Chain Finance (SCF)?
SCF, also known as supplier finance or reverse factoring, is a financing solution that allows suppliers to get paid early on their invoices. This approach helps reduce the risk of supply chain disruptions and allows buyers and suppliers to utilize their working capital more effectively.
What sets SCF apart from other methods like factoring is that it’s arranged by the buyer, not the supplier. Additionally, suppliers can often access this finance at a lower cost because it’s based on the buyer’s credit rating rather than their own. This typically means suppliers get better rates compared to other financing options.
Sometimes, the term "supply chain finance" is used more broadly to include various supplier financing options, such as dynamic discounting. In dynamic discounting, buyers offer early payment on invoices in exchange for a discount. However, it's most commonly used to refer to reverse factoring specifically.
How Supply Chain Finance Works
The buyer starts by entering into an agreement and then collaborates with a supply chain finance provider to invite suppliers to join the program. Some programs are funded by a single bank or financial institution, while others are managed on a multi-funder basis through a technology platform.
Traditionally, buyers focused on onboarding their largest suppliers. However, advances in technology now enable companies to offer SCF to a much larger network of suppliers, potentially including hundreds or even thousands. User-friendly platforms and streamlined processes make it simple to onboard many suppliers quickly and with minimal effort.
Once the program is up and running, suppliers can request early payment on their invoices. The finance provider pays the supplier early, usually at a discount based on the buyer’s credit rating. The buyer then repays the finance provider on the original due date of the invoice. This setup helps suppliers get paid faster and helps buyers handle their cash flow more efficiently.
Supply Chain Finance Process
In a SCF process, the buyer first orders goods or services from the supplier. The supplier then sends an invoice with a payment term, typically due in 30, 60, or 90 days. Once the buyer approves the invoice, the supplier can request early payment through the SCF program.
A funder provides this early payment to the supplier minus a small fee. On the invoice’s original due date, the buyer repays the funder. For accurate accounting, buyers need to classify these arrangements as on-balance sheet items rather than bank debt.
Example of Supply Chain Finance
Let’s break down how a SCF solution works with a simple example:
Imagine a buyer ordering goods from a supplier. After delivering the goods, the supplier sends an invoice with payment terms of net 30 days, meaning the buyer has 30 days to pay.
If the supplier wants to get paid sooner, or if the buyer wants to keep their cash for other needs, they can use a SCF solution. Here’s how it works: a third party, like a financer or lender, immediately pays the supplier. The buyer then has more time to repay the financer, maybe extending the payment term to 60 days.
This setup benefits both sides: the buyer keeps their cash for a more extended period while maintaining a good relationship with the supplier, and the supplier gets paid immediately, improving their cash flow. Plus, there are other benefits, like smoother cash flow management and potentially better financial terms.
Benefits of Supply Chain Finance
SCF offers several benefits for both suppliers and buyers:
Benefits for Suppliers:
- Better Cash Flow: Suppliers can get paid faster for their invoices through SCF, which helps improve their cash flow and reduces the time it takes to receive payment (known as days sales outstanding, or DSO).
- Lower Financing Costs: The cost of borrowing through SCF is often lower than other options like factoring, making it a cost-effective way for suppliers to secure funding.
- Accurate Cash Forecasting: With more predictable payment timings, suppliers can better forecast their cash flow, assisting them in organizing and controlling their finances more effectively.
Benefits for Buyers:
- Enhanced Cash Flow: Buyers can also benefit by improving their cash flow, as SCF allows them to extend payment terms with suppliers without harming the supplier’s cash position.
- More robust Supply Chain: By offering SCF, buyers can help ensure their suppliers remain financially stable, lowering the likelihood of supply chain issues.
- Better Supplier Relationships: Providing access to affordable financing strengthens the relationship between buyers and suppliers, potentially giving buyers more leverage in negotiations and ensuring a more reliable supply chain.
Flexible Funding
Supply chain finance and dynamic discounting are different ways to manage cash flow, but some companies might benefit from using both. For example, a business might have extra cash at certain times of the year, which they can use for dynamic discounting to pay suppliers early in exchange for a discount. At other times, they might want to invest that cash elsewhere and rely on SCF instead.
One way to handle this is by using separate programs from different providers, but that can complicate things for suppliers. A better solution is to choose a provider that offers a flexible funding model, allowing the company to seamlessly switch between dynamic discounting and SCF as their needs change. This makes things smoother for suppliers and gives the company the flexibility to adjust its cash flow strategy without any added complexity.
Frequently Asked Questions (FAQs)
Why is Supply Chain Finance important?
SCF is a powerful way for companies to optimize their working capital. It allows buyers to improve their cash flow while keeping strong relationships with their suppliers. By bringing in a third party to pay invoices early, buyers can hold onto their cash longer. This setup is also beneficial for suppliers since they can get paid sooner without needing to borrow against their own credit. Instead, they can take advantage of the buyer’s credit rating, which often means better financing terms.
What’s the Difference Between Supply Chain Finance and Factoring?
SCF, also known as reverse factoring, differs from other methods in that regular factoring is in one key way. In a typical factoring arrangement, the supplier starts the process by selling their invoices to a third-party factor, who then collects payment from the buyer according to the original terms. In reverse factoring, however, the buyer takes the lead, asking the factor to pay the supplier upfront. The main difference lies in whose credit rating matters. Factoring relies on the supplier’s credit, while reverse factoring leverages the buyer’s credit rating, often resulting in better terms for the supplier.
How Do I Choose a Provider For Supply Chain Finance?
SCF is available from a range of providers, including traditional banks and specialized financial institutions. When selecting the right provider for your business, consider a few key factors. Look at the types of businesses they typically serve, how adaptable their solutions are to your needs, how well their system integrates with your current ERP and the breadth of their supplier network. These considerations will help you find a provider that fits your company’s specific requirements and enhances your SCF strategy.
UFUND: Innovating Supply Chain Finance
We’re making SCF easier and more accessible through blockchain technology. This approach helps businesses connect directly with investors, eliminating intermediaries and simplifying the process of securing the funding they need.
By using the Polygon blockchain, we ensure transactions are secure and transparent, making the process smoother and more cost-effective compared to traditional methods.
Businesses can choose from various funding options with us, including our Token, significant cryptocurrencies, or traditional currencies. This variety allows companies to select the option that best suits their needs.
We also prioritize clarity and simplicity, helping businesses easily grasp their financing choices and better manage their cash flow. With these improvements, we at UFUND are making supply chain finance work better for everyone involved.
Ready to innovate your financing?
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