How supply chain finance works: All you need to know

As supply chains stretch further between international Suppliers (Exporters) and Buyers (Importers) there is growing pressure to free up the liquidity trapped within those supply chains. 

It's estimated that $523 billion (USD) of liquidity remains locked within the supply chains of the S&P 1500 companies, based on 2021 year-end figures.

Working capital remains a constant necessity for Buyers and Suppliers. Supply chain finance - also known as reverse factoring - is an efficient solution to achieve an optimised and consistent flow of working capital within a business.

What is supply chain finance?

Supply chain finance involves a shared arrangement between Exporters and Importers engaged in international trade. Financial institutions offer it to enable both parties to manage their invoice payment terms, maintain liquidity and keep money flowing freely through their supply chains.

Most supply chain finance arrangements are instigated by Importers that are often larger, more established and have better credit histories than Suppliers which are typically based in emerging countries and markets. 

How is supply chain finance different from invoice factoring? 

Exporters utilise invoice factoring for immediate working capital. Exporters sell unpaid invoices to a third-party factoring company in exchange for direct funds which they can use elsewhere. The invoice factoring company typically pays a large percentage of the invoice value up front, with the balance (less a fee for the service) paid on the invoice due date. If the Importer doesn't pay, responsibility for chasing late payments will usually fall to the factoring company.

Exporters may use invoice factoring to maintain liquidity or mitigate the risk of non-payment from new international Importers. Invoice factoring often occurs at the start of a new Importer-Exporter trading relationship.

Conversely, supply chain finance is often initiated by the Importer, incentivising Exporters to receive early payment for their goods.

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

How does supply chain finance work?

The supply chain finance process varies from deal to deal. Traditionally, the process comprises the following steps:

• Buyers and Suppliers conduct a business deal within a shared online account (operated by a financial institution).
• The Supplier sends an invoice to the Buyer for approval.
• The Buyer approves the invoice and is presented with an early payment discount option.
• Suppliers can opt to take early payment on some invoices.
• Both parties can access the supply chain finance platform to see all approved invoices.

Charges and fees will vary depending on chosen payment dates, which are at the Suppliers' discretion. Suppliers also have the flexibility to decide which invoices need to be paid and at what times. Buyers may look for extended payment terms to ease their cash flow, deferring invoice payments without impacting their Suppliers.

It's important to note that funds are advanced based on the Buyer's promises to pay and finance rates are based on the Buyer's risk profile.

Why is supply chain finance increasingly important?

Supply chain finance helps to manage the flow and security of trade across supply chains which can be affected drastically by a failed or late delivery. International trade has benefited significantly from globalisation at the expense of longer and more complex supply chains. 

A mutual supply chain finance arrangement benefits both parties. Buyers can purchase goods at discounted prices if they pay early and Suppliers can get funds earlier than arranged. This increases working capital, secures trade flow in the supply chain and enables both parties to invest in other areas of their businesses.

Traditionally, in international trade, Buyers often demand deferred payment terms from Suppliers. These terms can span anywhere from 30 to 180 days and may create cash flow problems for Suppliers, particularly those without instant access to credit or banking infrastructure. Supply chain finance can ease these problems.

How to set up supply chain finance  

Banks or finance providers can set up secure online invoice management accounts for supply chain finance. Choosing the right provider will depend on the industry and the types of goods and services provided. 

Supply chain finance is common in various industries, including:

• Automotive
• Retail
• Engineering
• Manufacturing
• Chemical

Each industry has different requirements, so finance providers may structure their supply chain financing services differently depending on the beneficiary.

Advantages of supply chain finance

Stability - With the early payment of invoices, Suppliers are more likely to withstand financial pressures that could limit their ability to deliver quality goods or services on time.

Reduced costs - Suppliers have flexible control over their working capital, controlling when and how many of their invoices need to be funded. The Buyer can also benefit from extended payment terms to help manage cash flow. 

Inexpensive credit - Small and medium-sized enterprises (SMEs) are more likely to be refused a loan from a bank or financial institution. Supply chain finance is not classified as a standard loan, so it can be an efficient way for business owners to obtain short-term credit without much risk.

Speed - Supply chain finance is often quicker to arrange than a loan because it depends on fewer criteria.

Disadvantages of supply chain finance

Risk - Businesses must put up collateral when arranging a bank loan but this isn't necessarily so with supply chain finance. Therefore, companies are at a higher risk of insolvency by stretching themselves financially.

Reduction in profit - Supply chain finance fees can reduce a company's profit margins, so they must be considered before the arrangement is made.

If you are interested in learning more about the content listed above, Stenn has a dedicated FAQ section where you can find more information about our invoice financing services. We also provide videos which explain the company and the financing process in detail.

About the authors

This article is authored by the Stenn research team and is part of our educational series.

Stenn is the largest and fastest-growing online platform for financing small and medium-sized businesses engaged in international trade. It is based in London, provides financing services in 74 countries and is backed by financial giants like HSBC, Barclays, Natixis and many others.

Stenn provides liquid cash to SMEs within the global financial system. On stenn.com you can apply online for financing and trade credit protection from $10 000 to $10 million (USD). Only two documents are required. No collateral is needed and funds are transferred within 48 hours of approval.

Check the financing limit available on your deal or go straight to Stenn's easy online application form.

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Disclaimer: The above article has been prepared on the basis of Stenn's understanding of the subject. 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.