Specialist finance

What is supply chain finance?

Supply chain finance is a type of business funding used by large buyers, such as supermarkets, to facilitate and improve transactions within their supply chain. It means their suppliers can access funds early, and the buyers themselves can delay payment without penalty. It improves cash flow for both parties, each paying a fee to a third-party financier.

Supply chain finance can also be known as supplier finance or reverse factoring; this is because it is similar to invoice finance, although the buyer (rather than the seller) initiates it.

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What is supply chain finance?

As the name suggests, supply chain finance is the financing of supply chains. It's a relatively new term, but the concept has been around for a long time. It predates even credit cards and bank accounts, with traders using letters of credit as early as the 18th century to guarantee payment for goods from overseas suppliers.

How does supply chain finance work?

Supply chain finance is a financial tool that allows businesses to sell their products on credit while the companies they purchase from do the same. This creates a closed credit loop throughout the supply chain, allowing companies to grow without increasing their debt load.

Businesses sell their products or services on credit to customers and vendors who pay them back over time (usually 30 days). The business receives cash immediately when it sells its product or service but doesn't have to wait until the end of 30 days for payment from its customer or vendor. A bank funds this cash advance through factoring agreements with suppliers, customers and third parties who guarantee payment for purchases made by businesses that use this method of financing.

As soon as a company signs an agreement with its bank (also known as its prime lender), it can use supply chain finance to obtain immediate cash advances for its daily business activities. Typically, the buyer is a larger business than their supplier. They have a better credit rating, so they can secure better terms from the financier.

An example would be a large supermarket such as Coles or Woolworths. They would offer supply chain finance to their huge number of suppliers, often as a prerequisite for doing business with them. The risks for the financier from such a large business are low, and the favourable rates they get are passed on to the suppliers, who'd be unable to obtain such terms themselves.

What are the advantages of supply chain finance?

In traditional business transactions, there are conflicting interests. Suppliers want to get paid as quickly as possible for cash flow reasons, and buyers want to delay payment. Supply chain finance addresses both of these needs:

Suppliers can get paid early, helping them to avoid potential cash flow gaps. Buyers can delay settlement, with this extended payment period bolstering their cash flow. This also means they can avoid potential late payment penalties.

Reverse factoring encourages collaboration and improves relationships in the supply chain. Whilst dealing with large supermarkets is a key objective for many small businesses, the resulting cash flow issues can prove a real dilemma for them.

Supply chain finance platforms and financiers

Supply chain finance requires the involvement of a supply chain finance platform, web-based software which often integrates with the accounting platforms of both the buyer and the supplier. It is backed by a financial institution that often runs the platform. Both parties pay fees. The supplier's fee is linked to how quickly they want to receive funds.

Benefits of supply chain finance

Table Example
Benefits of supply chain finance to the buyer Benefits of supply chain finance to the seller
Delayed accounts payable, leading to improved cash flow Invoices paid early rather than 30 days or more, improving cash flow
Improved relationship with their sellers - helps to facilitate deals by removing potential supplier cash flow issues Fosters cooperation and relationships with big buyers. It may even be a requirement of dealing with the buyers.
Allows suppliers to make deals that may not otherwise have been possible Longer payment terms without having to negotiate on price
Improved cash conversion cycle - the time it takes from the purchase of raw materials or production of goods to receiving payment Early payment discounts may be available, whilst invoices are paid at maturity / past due date
Faster access to cash allowing businesses to grow, hire staff and fulfil more orders Can negotiate better rates with suppliers upfront Reduced accounts receivable meaning reduced admin and less risk

Disadvantages of supply chain finance

Supply chain finance is not a panacea and is not suitable for all businesses. For example, if you're a high-growth company or one that sells expensive products with long payback periods, you may find that supply chain finance isn't the right solution for your business. Supply chain finance also doesn't help if your business needs capital to purchase inventory but doesn't have any sales at the moment (for example, during the holiday season).

An alternative to supply chain finance: Invoice finance

Invoice finance is a type of short-term funding used by businesses looking to ease cash flow gaps. Funds are secured using the capital tied up in invoices issued by the business.

Invoice finance takes the form of upfront funds or a line of credit. These can be:

  • Invoice factoring, where the invoice ledger is purchased by a third party who is responsible for collections, or
  • Invoice discounting, where collections remain the borrower's business and the invoices are used as security only.
  • Invoice finance is used to assist with cash flow problems caused by payment terms from a business' debtors.

Disclaimer: always refer to professional advice. The information presented here is purely indicative and not intended as advice. Always consult a legal or finance professional.

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