Supply Chain Finance – How it works and is it right for your business?

What is supply chain finance?

The phrase ‘supply chain finance’ can be used as a general description of all transactions within the realm of trade finance, or as a specific label from a particular kind of arrangement between suppliers and buyers. In this article we will concentrate on the latter.

In a simple supply chain, goods flow from supplier to manufacturer, to distributor, to end customer. Conversely, cash flows back up the chain from the end customer to the supplier.

Supply chain finance (also known as ‘reverse factoring’) refers to shared online accounts that are offered by financial institutions to enable buyers and suppliers to manage their invoice payment terms, maintain liquidity and keep cash moving freely through a supply chain. 

In supply chain finance, funding arrangements are often initiated by buyers, particularly when they are larger and have better credit ratings than suppliers who may well be small businesses in emerging countries. It typically evolves in trading relationships where suppliers and buyers have a solid trade history.

What is invoice factoring? And how is it different?

In contrast, invoice factoring is often initiated by suppliers and refers to a process in which suppliers sell their unpaid invoices to a third party (a ‘factoring company’) in exchange for immediate funds which they can invest elsewhere. They may do this to maintain liquidity or to remove the risk of non-payment with new buyers. Invoice factoring often happens in new trading relationships where suppliers and buyers have no history. Read more about invoice factoring here.

How does supply chain finance work?

Traditionally, in overseas trade, suppliers (exporters) encourage buyers (importers) to purchase goods by offering credit in the form of deferred payments. That is, goods are shipped but buyers are not asked to make payment for them until 30, 60 or 90 days later. This can create cash flow pressures for suppliers, particularly smaller companies without easy access to bank credit. 

Supply chain finance offers a way to ease those cash flow pressures.

Typically, supply chain finance works in the following way:

Buyers and suppliers conduct business within a shared online account set up by a financial institution. This account gives control of invoices and payment dates to both parties. 

Once buyers have approved an invoice, an early payment option is made available to them. As its name suggests, this offers the benefit of a discount on the total cost if they pay earlier than the due date. Suppliers can also opt to take early payment on some invoices.

This arrangement benefits both parties: buyers can get the goods at discount while suppliers can get funds earlier than arranged. This increases working capital and allows both parties to invest in other areas to boost growth. It’s a mutually beneficial arrangement that secures the flow of trade in the supply chain.

Finance charges will vary according to the dates of payment chosen by the supplier. Within the above framework, suppliers are given the flexibility of dictating payment terms and selecting exactly which of their total invoices they want funded at any given time. Buyers may also seek to extend payment terms if it benefits their cash flow, meaning they can defer payment without negatively impacting their suppliers. It’s the financing institution that will bear the load, not the supplier. And since funds are advanced based on the buyer’s promise to pay, rates for that finance are based on the buyer’s risk, not the supplier’s.

Why is supply chain finance increasingly important?

Globalisation has delivered many benefits to international trade but has made supply chains longer and more complex. 

It only takes one late or non-delivery to bottleneck the flow of trade. This is why supply chain finance has become an invaluable tool for managing the security and flow of trade within supply chains.

How to set up supply chain finance  

Businesses can approach a range of banks or finance providers to set up a secure online invoice management account for supply chain finance. The optimum lender for a business will depend on its industry, and the types of goods and services it provides.

Invoice factoring vs supply chain finance 

With invoice factoring, a supplier sells its invoices to a finance provider together with the responsibility for chasing payment if the invoice doesn’t get paid. 

This removes financial risk from the supplier. The factor collects payment of the unpaid invoices and charges the supplier an agreed fee for advancing funds and bearing the risk. 

The essential difference between invoice factoring and supply chain finance is that supply chain finance involves businesses managing invoice payment terms and holding onto responsibility for chasing unpaid invoices. 

What costs are involved in supply chain finance?

Invoice factoring removes all risk of non-payment while supply chain finance doesn’t, so fees for the latter would typically be lower.

Supply chain finance for different industries

Supply chain finance is common in a range of industries, including automotive, manufacturing, retail, chemical industries, and engineering. Each industry has its own requirements and finance providers may tailor their offerings accordingly.

Supply chain finance arrangements often exist where large, creditworthy buyers may be receiving goods from many small suppliers. The credit history of the buyers assures financiers that the risk of non-payment of invoices is low. 

Advantages of supply chain finance

• Stability - With the early payment of invoices, suppliers are more likely to withstand financial pressure that could limit their ability to deliver quality goods or services on time.
• Reduced costs - Flexible control of working capital is another advantage. Suppliers have complete control over when and how many of their invoices they want funded. The buyer can also benefit from the option of extending payment terms to help manage cash flow. In this way, supply chain finance is mutually beneficial to both suppliers and buyers.
• Inexpensive credit – Small- and medium-sized businesses are more likely to be refused a loan from a bank or financial institution. However, supply chain finance is not classified as a loan, so can be a useful way to obtain short-term credit that is relatively inexpensive and low-risk.
• Speed - Supply chain finance is typically quicker to arrange than alternative finance solutions since it is not a loan.

Disadvantages of supply chain finance

• Risk - With a traditional loan, a business is required to put up collateral but this is not a requirement for supply chain finance. Therefore, a company may stretch itself financially and be at greater risk of insolvency. 
• Reduction in profit - The fees associated with supply chain finance obviously reduce a company’s profit margins.

To discuss the supply chain finance options best suited to your business, contact Stenn’s expert team of advisors.

About the Authors

Stenn is a registered member of the ITFA, IFA and WOA. It has financed invoices worth over $7 billion (USD) to date and provides:

• An online platform for easy applications.
• Non-recourse factoring (i.e. full protection against non-payment of invoices).
• Rapid assessments (usually within 15 minutes).
• Cash advances within 48 hours, with only two documents to sign.
• Advances of between $10K (USD) to $10M (USD).
• Fees that begin at 0.65%.
• Advances on international deals that other companies and banks can’t, or won’t, finance.
• Services in 74 countries.
• Reverse factoring (buyers can use Stenn to pay immediately and settle the invoice later with us).

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Disclaimer: The above article has been prepared on the basis of Stenn’s understanding of current invoice factoring. It is for information only and doesn’t constitute advice or recommendation. Whilst every care has been taken in preparing this article, we cannot guarantee that inaccuracies will not occur. Stenn International Ltd. will not be held responsible for any loss, damage or inconvenience caused as a result of anything published above. All those applying for credit should seek professional advice when doing so.

Discover our other guides

To find out more about different types of trade finance, check out our other informational guides.
Alternatively, contact our team of friendly invoice factoring experts to discover if Stenn can support you with your unpaid invoices.