A win-win situation: Supply chain financing helps free up cash that would otherwise be trapped in the supply chain. Photo credit: Unsplash
Have you heard of supply chain financing (SCF), also known as reverse factoring or approved payables finance?
SCF refers to a financial arrangement between three parties – an anchor buyer, a supplier and a financier – that aims to improve the cashflow of the supplier while extending the payable days for the buyer.
In this scenario, the financier relies on the strong credit quality of the buyer to grant an early payment to the supplier for a nominal fee.
In a typical supply chain set-up, a buyer purchases goods from a supplier with a pre-agreed credit term, which ranges from 30 to 180 days.
The supplier is often caught in a cash trap where much of his working capital is stuck in receivables. He can go to a bank to obtain working capital financing through a short-term working capital facility or export invoice financing.
However, smaller businesses may find it difficult to obtain credit from lenders. Therefore, the supplier will try to shorten his credit terms as much as possible against the buyer’s interest.
Here is how SCF aims to address this zero-sum game.
SCF works with a financier being an intermediary between the buyer and the supplier. It starts with a financier holding a credit relationship with an anchor buyer that is a large and creditworthy company.
The credit comfort with the buyer allows the financier to be confident of the buyer’s ability to make good on his payments to suppliers when they are due.
Thus, financiers rely on the creditworthiness of the buyer to grant an early payment to suppliers at a fee. Eventually, the buyer makes the payment in full to the financier and the transaction is complete.
In this way, the supplier gets quicker access to funds owed, hence increasing his working capital. Meanwhile, the buyer gets to improve his cashflow through extended payment terms at no cost.
In short, SCF is a working capital solution that enables buyers and suppliers to optimize their cashflow and improve liquidity.
The whole process minimizes risks across the supply chain, which is increasingly getting longer these days because of globalization, and of course, the disruption brought about by the COVID-19 pandemic.
By freeing up cash that would otherwise be trapped in the supply chain, both buyers and suppliers have a better chance of surviving economic headwinds and scaling their businesses.
For invoice financing and invoice factoring, it is the supplier (the party waiting to get paid by the buyer) who respectively pledges and sells his invoices in order to get paid more quickly.
Yet for SCF, it is the buyer (or customer) who makes the call on which approved invoices they want to pay the supplier sooner.
Once the supplier has received payment from the financier, the latter then collects the payment from the buyer.
Since this arrangement is initiated by the buyer and not the supplier, the interest rate is usually lower than what it would have been if the supplier had sought financing on his own.
This is because the financing rates are based on the buyer’s risk, and not the supplier’s. In addition, the financier is only making the early transfer based on the buyer’s promise that he will pay the financier by the invoice’s original maturity date.
So while the supplier can get paid by the financier via SCF the next working day (as compared to the usual 30- to 60-day payment terms), the ordering party or buyer is able to make payment only on the due date.
The entire process is summarized step by step here:
1. Supplier submits the invoice to the buyer.
2. Buyer approves invoice; and uploads it to a portal.
3. Supplier logs into portal to check all approved invoices. If no action is taken, funds will be paid when the invoice reaches its maturity date. Or, the supplier can sell his receivables to the financier for an early payment.
4. Funding instructions for the early payment request are sent to the financier.
5. Financier pays agreed discounted amount (accounting for a small financing fee) to the supplier’s bank account the next working day.
6. Buyer makes payment to the financier on original due date.
While the benefits to the supplier are obvious, SCF, if managed well, can yield many benefits for anchor buyers beyond extended payment terms such as:
Being a collaborative process between the buyer, supplier and the financier, and more importantly, a largely win-win one at that, SCF is likely to result in all three parties having stronger relationships with one another.
With help from the financier, the buyer can take some stress off his payment cycle by negotiating a longer payment term.
The supplier can gain better control of his cashflow by requesting for an early payment when required or allowing his receivables to run to maturity.
If managed well, this can help the buyer improve his relationship with the supplier and provide room for price negotiation in the future.
Typically, the solution is entirely provided by the financier and imposes zero costs to the anchor buyer to administer and implement.
As such, it is important for the financier to evaluate if there will be sufficient utilization as it profits from the fee imposed from each transaction.
It is worth noting that SCF does not constitute additional debt to the buyer or supplier as it is an extension of the buyer’s accounts payable. For the supplier, it involves selling his receivables.
Existing SCF solution providers should be able to integrate seamlessly with the ERP systems of anchor buyers.
This allows buyers to have complete visibility on approved invoices and payments being made.
This is likely to lead to fewer errors in the payment cycle, and will also help the buyer to manage his payables more effectively.
IFS Capital Limited has partnered PrimeRevenue to provide supply chain finance solutions in Southeast Asia. Visit www.ifscapital.com.sg/supply-chain-financing for more details.
This is the shortened version of an article that was first published in Lendingpot’s October 2021 newsletter.
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Belinda loves thinking about random stuff, and collecting useless bits of facts and trivia. She often roots for the underdog, and believes the world needs more happy endings.