Supply Chain Finance: What It Is, How It Works, Example

Navigating the complexities of today's business ecosystem can be a daunting task, especially when it comes to managing the financial aspects of supply chains. This is where Supply Chain Finance (SCF) comes into play, serving as a vital tool to improve liquidity, strengthen supplier relationships, and optimize working capital for both buyers and suppliers. Whether you're a business owner trying to understand how to make your supply chain more resilient or an investor looking for an alternative high-yielding debt investment, understanding the intricacies of SCF can offer significant advantages.

What Is Supply Chain Finance?

Supply chain finance means that in the fast-paced world, the focus on maintaining a resilient and efficient supply chain has never been more critical. Supply Chain Finance (SCF), alternatively known as supplier finance or reverse factoring, addresses this requirement by emerging as an invaluable supplier financing solution. Acting as a financial lifeline for suppliers, SCF allows for the early payment of invoices, thus mitigating the risks tied to supply chain disruptions. In doing so, it ensures smoother operations for both buyers and suppliers, fortifying the entire supply chain ecosystem.

Unlike traditional financing methods like factoring, which are initiated by suppliers, SCF stands out as it is set up by the buyer. This unique feature allows the vendor financing costs to be determined by the buyer’s credit rating rather than the supplier’s. As a result, suppliers often find that they can access funding at more favorable rates, contributing to the overall financial health of the supply chain.

Although the term 'Supply Chain Finance' can sometimes be used more broadly to include other supplier financing solutions such as invoice discounting, export financing and dynamic discounting, it is most commonly identified with reverse factoring. Dynamic discounting enables suppliers to receive early payment on their invoices in exchange for offering a discount to the buyer, but SCF remains distinct in its approach and benefits.

How does supply chain finance work?

Initially, the buyer forms a partnership with a supply chain finance service provider and then invites its supplier network to participate in the program. Unlike the conventional model where a single bank or financial institution funds the program, today's supply chain finance programs can be multi-funded. This is often managed by tech-savvy specialists who operate via a specialized digital platform.

In the past, companies primarily focused on incorporating their top 20 or 50 suppliers into their supply chain finance initiatives. However, advancements in technology now allow businesses to extend these programs to a broader range of suppliers—potentially numbering in the hundreds or even thousands, spanning global supply chains. This has been made feasible thanks to intuitive platforms that simplify the onboarding process, enabling a large scale of supplier participation with minimal hassle.

Once the program is operational, suppliers have the option to seek early payments on their invoices. The mechanics of the supply chain finance then unfold, usually following a specific set of procedures, which we will detail further in this blog.

Supply Chain Finance Process

Once the program is in action, suppliers can request early payment on their invoices. Typically, the SCF process follows these steps:

• Supplier submits an invoice to the buyer
• Buyer approves the invoice
• Invoice details are uploaded to the SCF platform
• Supplier requests early payment through the platfor.
• SCF provider funds the early payment based on the buyer’s creditworthiness
• Buyer settles the invoice on the agreed-upon date, reimbursing the SCF provider

Supply Chain Finance Example

To show how supply chain finance works, let's consider a practical, hypothetical scenario as an example.

Imagine a scenario where a buyer orders a batch of goods from a seller. Normally, once the seller ships these goods, they would issue an invoice with specified payment terms, for instance, net 30 days. This arrangement typically gives the buyer a 30-day period to settle the invoice.

In some cases, the seller might need prompt payment to manage their cash flow better, or the buyer might prefer to retain their cash longer for operational use. In such situations, they can turn to a supply chain finance solution. This introduces a third party into the equation – a financier or lender.

The financier's role is pivotal here. They step in to pay the invoice amount directly to the seller on behalf of the buyer, effectively settling the invoice immediately. Subsequently, the financier extends the payment terms for the buyer, possibly to 60 days, instead of the original 30.

This arrangement benefits both parties significantly. The buyer enjoys the flexibility of extended payment terms, allowing them to utilize their working capital more effectively without straining their relationship with the seller. Meanwhile, the seller benefits from immediate payment, boosting their own working capital and enabling them to invest in their business operations. Additionally, this solution offers several other advantages, fostering a mutually beneficial financial relationship between the buyer and the seller.

Conclusion

Supply chain finance serves as a multifaceted solution, providing invaluable benefits to both buyers and suppliers in the modern business ecosystem. It optimizes working capital, reduces risk, and strengthens business relationships, creating a win-win situation for all parties involved. As technology continues to advance, SCF platforms are becoming more accessible and scalable, allowing even small and medium-sized enterprises to take advantage of this financial innovation. Whether you're a supplier looking to improve cash flow or a buyer aiming to bolster supplier relationships and manage capital more efficiently, SCF offers a robust solution. Understanding its ins and outs not only offers immediate financial benefits but also contributes to long-term business stability and growth.