Supply chain finance helps businesses manage their working capital, but it comes with benefits and challenges says the UK government-owned development bank, the BBB.
Supply chain finance, also known as reverse factoring and supplier finance, helps with cash flow for companies at both ends of the supply chain.
It gives the buying business more time to pay suppliers while also allowing suppliers to benefit from being paid early.
Supply chain finance involves a supplier receiving early payment of an invoice by a finance company.
The business that has purchased the goods or service then pays the funder once the invoice is due.
The full process for supply chain finance is as follows:
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- The business buys goods or services from a supplier
- The supplier issues an invoice to the buyer with payment terms outlining when it needs to be paid
- The buyer approves the invoice and uploads it to a supply chain finance platform
- The supplier uses the platform to request early payment of the invoice
- The lender sends the payment to the supplier, minus a fee which is based on the credit rating of the buying business
- The buyer pays the finance company providing the supply chain finance when the invoice payment is due according to the payment terms.
Key benefits of supply chain finance include:
Optimising working capital: Supply chain finance can provide working capital advantages for both suppliers and the buying business. A supplier receives payment for their invoice earlier than they would have otherwise, while the buyer benefits from longer payment terms which keeps working capital in the business for longer and helps improve cash flow.
Strengthened relationships with suppliers: The cost of supply chain finance is based on the buyer’s credit rating, which means suppliers can usually access the facility at a lower rate than other funding sources. By providing them with access to this low-cost form of funding as well as an early payment of invoices, businesses can improve their supplier relationships without worrying about damaging the relationship due to making late payments.
Negotiating deals with suppliers: Supply chain finance could give businesses a commercial advantage when negotiating the terms of a deal with a supplier. It can make them more attractive to work with and could lead to benefits such as better prices, a discount on larger orders or quicker shipping times.
Cutting supply chain risk: Giving suppliers access to supply chain finance helps to reduce the chance of disruption to a business’s supply chain due to a supplier going bust.
Supplier management: For businesses with multiple suppliers, routing all payments through one supply chain finance system could help to reduce costs and improve efficiency.
There are some potential drawbacks of supply chain finance, however.
Eligibility criteria: Supply chain finance is generally only available to businesses that have been trading for a few years and have a good credit history. There may also be a minimum spend for invoices covered by the finance agreement. This means it is unlikely to be accessible to newer start-ups and businesses with poor credit scores, or those making smaller orders.
Fees: If a supplier requests early payment of an invoice, they do not receive the full value of the invoice due to the fee deducted by the finance company, which is usually between 10% and 20%. This could put a supplier off from joining a supply chain finance agreement.
Technology integration: For full automation of invoice payments, supply chain finance requires integration with the buying business’ existing IT systems. This can be costly and complex. Businesses may need to employ the services of external experts to ensure a successful integration.
Order limits: A finance company will only cover the invoice values covered by the agreement. This means if a business makes an order that exceeds the agreed limit, the finance company will not pay the invoice, which could have cash flow implications.
Banks and non-banking finance providers offer supply chain finance. When considering providers, looking for one who understands your sector and has experience working with businesses like yours can be a good idea. They should have a good reputation and strong customer service, so search online, consult review websites, and ask fellow business owners and other contacts for recommendations.
If you are part of a business membership or networking group, they may have existing relationships with finance providers that you could benefit from. Using a supply chain finance provider with an international presence and expertise can be a good idea if your business operates globally.
You should also consider how the provider’s solutions fit with your IT systems. Draw up a shortlist of providers and consider their eligibility criteria and fees. Consult your suppliers to ensure they are on board with your plans. You may wish to ask an independent finance expert for help with selecting the best supply chain finance solution for your business and your suppliers.