Supply chain financing / reverse factoring

Supply chain finance is a fast growing option — for companies looking to optimize cash flow.

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What is supply chain finance?

Supply chain finance (SCF) refers to a set of tools or solutions that seek to optimize cash flow or working capital. It enables buyers to lengthen their payment terms, with suppliers, while at the same time giving suppliers the option to receive payments earlier.

Supply chain finance is an ever-growing method of addressing cash flow and liquidity challenges — in both domestic and international trade.

Supply chain financing is fundamentally a collaborative process, where three parties have an arrangement together — lender, buyer and supplier. It is also known as reverse factoring or supplier finance.

Like trade credit, reverse factoring can be seen as a form of working capital finance and as an alternative funding solution.

Supply chain finance — considerations

Buyers and suppliers in a supply chain typically have competing interests — when it comes to payment. Buyers want to pay as late as possible, while suppliers want to be paid quickly. Supply chain finance is the bridge that makes both parties happy.

Supply chain financing is essentially a type of cash advance — in a way similar to invoice financing. It can be thought of as a means for smaller suppliers to benefit from the higher credit ratings — that their buyers have.

These buyers are often much bigger corporate organizations — who are almost certain to honor their invoices. Due to the risk of non-payment being low, lenders are willing to advance almost 100% of the value of these invoices — once the buyer has approved payment. A discount fee will usually be deducted from any money advanced to the supplier.

Supply chain finance is favorable to both buyer and supplier — as it helps them manage working capital, provides liquidity and minimizes supply chain risks.

Another advantage of supply chain financing is that buyers are not charged for extending their payment terms, while suppliers only pay a small discount fee — should they exercise their right to get paid earlier. It is truly a win-win solution for both parties.

Supply chain finance is popular in a number of industry sectors such as manufacturing, automotive, retail, electronics, energy, transportation, food and many others.

How does supply chain finance work?

Businesses would need to look for a lender that specializes in supply chain financing or reverse factoring. Once a suitable lender has been identified — a lending facility may be set up.

Lenders would need to assess if both supplier and buyer meet their lending criteria. Details of both businesses would be required including company turnover, statement of accounts, credit ratings etc.

More importance will be placed on the buyer, as they are ultimately leveraging their credit ratings — to get cheaper financing for the smaller supplier. In other words, funds are lent based almost exclusively on the buyer’s risk — not the supplier’s.

Once the SCF facility is approved — a supplier may begin issuing invoices to the buyer. The buyer will then approve the invoice, and upload the data to a supply chain finance platform.

Suppliers are then able to log into the SCF platform and review all approved invoices. Using this platform, suppliers can then sell (discount) these invoices to the lender, who will advance funds to them — minus a small financing fee or discount.

Alternatively, suppliers can simply wait until invoice maturity — where funds will settle directly into their bank account (without paying any fees).

As soon as the invoice matures, buyers pay the full invoice amount — to either the lender or the supplier (depending on if money was borrowed or not).

Benefits of supply chain finance

  • Buyers get longer supplier payment terms
  • Buyers can purchase in bulk
  • Suppliers get paid faster
  • Suppliers get access to a cheaper funding solution
  • Fosters cooperation between buyer and supplier
  • Can be used with other funding solutions
  • Can be managed online — in real time

Limitations of supply chain finance

  • Extending payment terms — may force suppliers to pay an SCF fee, to get paid early
  • Solutions can be complex and difficult to understand

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