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March 17, 2021updated 23 Mar 2021 6:48pm

Supply chain finance and invoice finance: divided by a common language

By Alejandro Gonzalez

Greensill Capital, a provider of supply chain financing that fell into administration last week, funded several transactions between Sanjeev Gupta’s businesses (GFG Alliance) and linked companies. In the article below, Matthew Davies, the director of invoice finance and asset-based lending for UK Finance, offers a primer on supply chain finance vis-a-vis invoice finance. 

Supply chain finance has been in the news recently for reasons which have nothing to do with the nature of the product itself, which is an important finance option for businesses around the world. Indeed, the focus of the current scrutiny is far removed from the actual purpose of the product, which is supporting businesses trading in the real economy.

And in the context of such critical scrutiny, it is also vital to remember the importance of being clear about what exactly is being referred to with the term ‘supply chain finance’ in these instances and, perhaps more importantly, what is not.

(Pictured: Matthew Davies of UK Finance)

Trade finance

The trade finance sector can be broadly described as facilitating the buying or selling of goods or services between two businesses. Whether this falls under ‘invoice finance’ or ‘supply chain finance’ depends on whether the finance provider has a relationship with the supplier or the purchaser.

Invoice finance (receivables finance)

In the case that the driving relationship is between the supplier and the finance provider, the financier will make a prepayment to the supplier when an invoice is raised, normally at a discount, with the purchaser then paying the full amount when the payment is due. 

Where the client is the seller, the assets against which finance is provided are the debts owed to the business (its receivables). These are usually represented by its invoices, hence the term invoice finance. 

These represent legal obligations to pay that can be transferred (or ‘assigned’) to the finance provider. This means it is a highly secure type of finance, and often an IF provider can extend more finance than might be possible through other types of finance. The most common types of IF are factoring and invoice discounting.

Supply chain finance (payables finance)

Where the client is the purchaser business, finance will also be provided to allow the client’s suppliers to be paid early – again normally at some sort of discount – with the client business having an obligation to pay the full amount to the financier at a specified point in the future. 

However, in this case, finance is extended against a commitment to pay (a payable) and so the facility is based on the financial strength of the purchaser rather than the supplier. Essentially this is the opposite of invoice finance, hence in many jurisdictions around the world it is referred to as ‘reverse factoring’. 

In the UK it tends to be referred to as ‘supply chain finance’ although elsewhere that term is used somewhat confusingly to cover both payables and receivables finance.

Both supply chain finance (against payables) and invoice finance (against receivables) are important types of finance that support thousands of UK businesses employing hundreds of thousands of people. They use similar legal mechanisms and processes, and in some cases can be provided by the same institution. But the products are distinct not least in terms of the types of business that deploy them and the circumstances in which they should be appropriately used. 

Supply chain finance is generally used by larger corporates to accelerate payment to their suppliers, whereas invoice finance is a ‘bottom-up’ option chosen by small businesses up to corporates. 

Default risk 

They also bring with them different risks; in a supply chain finance arrangement the default risk will be concentrated in one place, the client business, however that client will likely be large and have greater financial strength. In an invoice finance arrangement, default risk is effectively spread across the debtor book. 

The current scrutiny of a prominent supply chain finance provider should be removed from the reputation of the product, as the current challenges are nothing to do with the nature of the product itself and appear to be all to do with the mechanisms used to fund itself. 

And even more importantly, it must be emphasised that it is misleading for the terms ‘invoice finance and ‘supply chain finance’ to be used interchangeably in the ways that they have been in recent coverage. And in the context of critical scrutiny, accuracy and consistency of terminology have never been more crucial.

 

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