Growth and expansion of a business are essential for sustainability and profitability. Small businesses, however, may not have the sufficient funds to meet their growth and operational objectives. They thus resort to financial institutions to meet the capital.
Vendor financing is a funding arrangement wherein a vendor assists a customer in availing finance either directly or indirectly. With the help of such capital availed, the customer then proceeds to purchase the said vendor’s goods or services. It is also known as – supplier finance or trade credit.
In most cases, vendor financing is treated as a deferred credit. Under this financing option, customers do not need to pay for their purchases immediately. They can do so after the sale of the finished products.
Typically, such loans accompany relatively high rates of interest, and borrowers may have to pledge an asset as collateral. Based on the customers’ market goodwill and their relationship with the vendor, they may extend funds against an agreement and without levying any interest rate.
The reason why vendor finance is rapidly becoming popular among vendors and purchasers can be understood by taking into consideration the following benefits
Benefits to vendors:
Benefits to purchasers:
Sometimes, businesses undergo a financial crisis because their accounts receivables get delayed or blocked. To ensure financial crunch does not interrupt production processes and everyday operations, businesses can alternatively opt for invoice discounting service. KredX is India’s leading integrated cash flow solutions provider that helps businesses access working capital by utilising their unpaid invoices within 24 to 72 hours*. KredX assures a paperless procedure and offers transparent solutions through zero-liability bill discounting to meet funding requirements easily.
Vendor financing broadly involves two different methods of funding, namely –
Through this financing option, borrowers can avail goods or services at sale prices, but they are required to pay interest at a predetermined rate. Vendors thus earn interest with each instalment payment.
If at any time a borrower fails to pay the vendor, he/she is marked as a defaulter. The credit amount is then written off and recorded under ‘bad debts’.
In this type of vendor financing, borrowers avail the required goods and services but in exchange for a set number of shares. In other words, borrowers do not have to pay vendors in cash under equity financing as they are paid in share units.
As a result, the vendor becomes a shareholder of the firm and receives dividends on the shares held. The higher this number of shares held by a vendor; the prominent is their influence on company management.
It is mostly small businesses that resort to equity or inventory financing. If they do not find the idea of availing credit in exchange for company shares convincing, they can opt for invoice discounting.
In the vendor finance arrangement, a borrower makes an initial deposit post agreeing to the vendor’s terms. Subsequently, the borrower has to repay the debt within a predefined repayment term.
Though the payment instalment may or may not be inclusive of interest, both the purchase price and the repayment amount are much higher than any regular credit. In case interest is levied on the purchase; the rate will be decided as per the terms and conditions agreed between the two parties.
Businesses often resort to a vendor finance arrangement as the last resort when they fail to meet the lending requirements laid down by financial institutes.
Let’s take a look at this simple example to understand the process of vendor financing.
A manufacturing company Stars Limited plans to purchase some raw material worth Rs. 1 lakh from a vendor Kamal. Due to the financial crunch, Stars Limited can manage to pay only Rs. 40,000 for the raw materials. Owing to the history of transactions and healthy business relation, the vendor agrees to provide raw materials worth Rs. 1 lakh after taking Rs. 40,000 from the company. He offers the company a note that mentions the particulars of the transaction and the agreed terms.
The vendor decided to charge 10% as interest on the outstanding dues for the term agreed by both parties. Through this arrangement, Stars Limited can procure the required raw material from Kamal. The company must pay back the remaining Rs. 60,000 in instalments in addition to the interest amount charged at the rate of 10%.
Several benefits accompany the arrangement of vendor financing, but it has its shares of limitations as well. Businesses must make it a point to weigh the pros and cons of this arrangement before going ahead with it.
Businesses can always resort to convenient digital funding options. KredX, provide invoice discounting services to help businesses meet their working capital needs within 24-72 hours*. We use advanced technology and thorough data analysis along with credit underwriting skills to provide you with timely funding. Get in touch with us to learn more!