Supply chain finance meaning is to offers a viable solution to this challenge by leveraging a financial intermediary to optimize cash flow for both suppliers and buyers. By utilizing supply chain finance, companies can enhance their working capital by improving payment processes, reducing payment delays, and enhancing cash flow management. This makes supply chain finance an attractive option for companies dealing with multiple suppliers globally, as it enables them to effectively manage payments, strengthen business relationships, and enhance overall financial performance.
The negotiation of payment terms between suppliers and buyers can be a time-consuming and complex process, as it significantly impacts the financials of both parties. Buyers often push for longer payment terms to benefit their cash flow, while suppliers may face challenges in managing their cash flow due to delayed payments. On the other hand, shorter payment terms can strain the buyer’s cash flow. This discrepancy in payment terms can sometimes lead to friction in business relationships and hinder smooth operations.
Supply Chain Finance (SCF)
Supply Chain Finance (SCF) is a strategic arrangement where a buyer collaborates with a financial institution to facilitate early payment to their suppliers. The buyer takes the initiative to set up the SCF program, and suppliers may need to enroll in it. Once the buyer purchases goods or services from a supplier, the supplier can request early payment from the financier, typically a bank, with a small fee deducted. The buyer then settles the financier at an agreed-upon future date.
The key advantage of supply chain finance, also known as reverse factoring, is that it allows suppliers to receive prompt payment within days, while buyers may secure longer payment terms than what suppliers offer. This can greatly enhance the financial position of both parties by improving cash flow and working capital. Companies often utilize SCF selectively, such as during off-peak seasons or when dealing with seasonal fluctuations in demand, to optimize their cash flow management.
Supply chain finance is a financing approach led by buyers, where they collaborate with a third-party financial institution to expedite payments to suppliers while extending payment terms for themselves. This arrangement allows suppliers to receive prompt payments within days, while buyers can defer invoice payments for several months. This strategy can enhance working capital for both parties and contribute to the sustainability of suppliers, thereby strengthening the overall supply chain for the customer.
Despite losing popularity for a period, supply chain finance is now experiencing a resurgence as businesses seek cost-effective sources of capital in the face of inflation and rising interest rates. This renewed interest highlights the relevance and value of supply chain finance as a strategic financing option for companies aiming to optimize their cash flow management and enhance their financial performance in today’s dynamic business environment.
Supply Chain Finance Explained
Supply chain finance sets itself apart from other types of financing such as AR factoring and lines of credit by being initiated and managed by the buyer. This buyer-led approach offers convenience to suppliers and can also be advantageous for them if the buyer has better credit, resulting in better rates compared to what the supplier could have obtained. Moreover, supply chain finance can be a more cost-effective option, with fees often being up to 10 times cheaper than other financing methods like receivables factoring. Many financiers also offer dynamic discounting, where the fee varies based on the timing of the supplier’s payment request, and buyers do not incur any direct costs for the extended payment terms.
Although supply chain finance lost popularity in the past due to widespread availability of cheap financing and increased regulatory scrutiny, it is now experiencing a resurgence. According to BCR Publishing, the global supply chain finance market grew nearly 40% to reach $1.8 trillion from 2020 to 2021. This trend highlights the renewed interest and growing recognition of the benefits of supply chain finance in today’s evolving business landscape.
Understanding the Mechanics of Supply Chain Finance
In modern times, supply chain finance is typically managed using specialized software that streamlines and automates the complex steps involved in the process. This software enables a self-serve approach, reducing the workload for both the buyer and the lender. Additionally, it’s worth noting that companies have flexibility in choosing their funding sources, and can opt for a combination of banks and other entities to participate in the supply chain finance initiative. This allows for customization and adaptability to suit the specific needs and preferences of the participating companies.
Steps Involved in the Supply Chain Finance Process
The supply chain finance process typically involves the following steps:
- Identification of Funding Source: The buyer identifies a suitable bank or financial institution, or even multiple lenders, that are willing to participate in their supply chain finance initiative.
- Invoice Approval: The purchaser reviews outstanding invoices from various suppliers and selects the ones they wish to approve for early payment. These approved invoices are then posted to the supply chain finance system, either through an integrated procurement solution or manually.
- Supplier Registration: The supplier registers for the supply chain finance program and gains access to the approved invoices. They can then choose which invoices they want to receive early payment for.
- Financing Fee Payment: The supplier pays a financing or transaction fee, and the approved payment amount is transferred to their account.
- Repayment to Lender: The purchaser repays the lender at a later date, typically after the initial due date for the order, based on the terms agreed upon with the financier. Any invoices that were not paid early are paid directly to the supplier by the due date.
These steps collectively facilitate the smooth functioning of the supply chain finance process, benefiting both the buyer and the supplier by optimizing cash flow and working capital management.
Advantages of Supply Chain Finance
We have already discussed the significant benefits of supply chain finance, but let’s highlight how this practice can advantage both suppliers and buyers. This will provide a clear understanding of how this arrangement can be beneficial for all parties involved.
- Increased Working Capital: Supply chain finance provides suppliers with access to cash, thereby increasing their working capital. This additional liquidity helps suppliers cover expenses, manage cash flow, and sustain their business operations in capital-intensive industries.
- Lower-cost Funding: Reverse factoring, a form of supply chain finance, allows suppliers to obtain funds at a lower cost compared to other financing options. This becomes particularly advantageous when interest rates on loans are high or rising rapidly, resulting in cost savings for suppliers.
- Predictable Cash Flow: Supply chain finance offers suppliers the option to receive early payment on their invoices, leading to a more predictable cash flow. This mitigates the uncertainties associated with delayed customer payments, and enables better cash forecasting, contributing to improved financial planning.
- Optimized Working Capital: Supply chain finance allows buyers to extend their payment terms with suppliers, enabling them to retain their cash for a longer period. This optimized working capital can be utilized for other business needs, such as capitalizing on short-term opportunities or addressing unexpected expenses.
- Enhanced Supply Chain Resilience: Supply chain disruptions, such as supplier insolvencies, can significantly impact a buyer’s operations. Supply chain finance provides suppliers with timely access to funds, helping them overcome financial difficulties and ensuring a stable supply of products or services to the buyers. This enhances the resilience of the entire supply chain.
- Strengthened Supplier Relationships: Supply chain finance can act as a competitive differentiator for buyers, as it offers suppliers access to affordable capital. This can lead to stronger relationships with suppliers, improved communication, early issue detection, and priority treatment during capacity constraints, resulting in a more reliable and efficient supply chain.
- Increased Negotiating Power: Being a preferred customer offering supply chain finance, buyers may have increased bargaining power with suppliers. This can result in better pricing, discounts, or other favorable terms, ultimately improving margins and profitability.
- Streamlined Payments: Supply chain finance allows for centralization of payments to a single financer, simplifying accounts payable processes and reducing administrative overheads associated with managing payments to multiple suppliers. This can result in cost savings and improved efficiency in payment management.
Supply Chain Finance Scenario
Let’s delve into a practical scenario to understand how supply chain finance works. Consider a health and beauty brand that sells its products through its own ecommerce website and distributes to a few large beauty store chains. The company relies on various suppliers for makeup, hair care products, skincare solutions, and other related items, some of which carry the retailer’s private label.
The health and beauty company has agreed upon 45- or 60-day payment terms with all of its suppliers. However, lately, more suppliers have been requesting early payment due to the increasing cost of materials. To avoid jeopardizing its own financial position by paying earlier than planned, the company decides to leverage supply chain finance.
It explores options with different lenders, including the bank with which it has a significant business relationship, and selects the one with the best combination of low fees and a proven track record of excellent service for both buyers and suppliers. Subsequently, the majority of suppliers sign up for the program. The health and beauty retailer starts uploading invoices approved for early payment to a system that is accessible to both the bank and suppliers.
When suppliers face cash flow constraints, they log into the system to review eligible invoices for immediate payment, along with the applicable fees, and select the ones they want to be paid early. This triggers an alert to the bank, which initiates the payment processing, and the supplier receives the payment within a few days. The purchaser does not need to facilitate this process in any way.
As part of the agreement, the business is granted net-90 terms instead of the original net-45 or net-60, which helps with cash flow management and boosts working capital. Consequently, three months after receiving the invoice, the company pays the bank the amount due for any payments that were fronted as part of the supply chain finance arrangement.
Challenges and Considerations of Supply Chain Finance
Supply chain finance can be a beneficial arrangement for both suppliers and customers, especially when cash flow is limited or when a company is allocating significant funds towards short-term strategic projects. However, relying too heavily on supply chain finance can pose financial risks for buyers, as evidenced by businesses and lenders that have faced financial difficulties after extending too many payments for too long.
Although this approach may have diminished in popularity in recent years, it is regaining traction as companies focus on cash management and payment cycles lengthen. Supply chain finance can also be a part of a broader supply chain resilience strategy, as it can position a company as a preferred customer during times of widespread shortages and delays. However, it is crucial for both parties to fully understand the nature of the agreement before opting for this type of financing and to use it judiciously in alignment with the business’s best interests.
Another challenge associated with supply chain finance is how the money owed by buyers to lenders is reflected on the balance sheet and cash flow statement. Despite receiving extended payment terms from financial institutions, current International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) guidelines allow purchasers to classify this money as accounts payable rather than as another type of liability, such as debt. However, this can create a misleading impression of a company’s available cash, considering the significant upcoming payments due to the lender.
As a result, supply chain finance has come under regulatory scrutiny in recent years, with the Financial Accounting Standards Board (FASB), which sets GAAP guidelines, considering a proposal and the Securities and Exchange Commission (SEC) offering guidance on the issue. This means that businesses may soon be required to track and disclose all supply chain finance activity during a specified period in their financial statements, adding an additional layer of complexity and compliance considerations.
How NetSuite Simplifies Supply Chain Finance Management
Managing supply chain finance can introduce complexities in financial management and transaction accounting. It involves additional sources of funds inflow or outflow, depending on whether a business is a supplier or a customer. Additionally, buyers need to keep track of and review all invoices to determine which are eligible for early payment to be communicated to the financer.
NetSuite’s cloud accounting solution streamlines this process by automatically tracking all invoices and recording supply chain finance transactions in the appropriate ledgers, ensuring clear audit trails. This enables easy visibility and disclosure of these agreements and the status of outstanding payments in financial statements and other communications with investors. Furthermore, the software generates the three essential financial statements that every business requires, including any obligations to financial institutions arising from supply chain finance arrangements.
In addition, NetSuite can seamlessly integrate with a separate supply chain finance system to accurately capture and record transactions and payment terms. This integration enables efficient uploading of invoices for buyers and enables suppliers to easily track requests for early payment. By leveraging NetSuite’s capabilities, businesses can effectively manage their supply chain finance activities, ensuring accurate and transparent financial reporting.
Frequently Asked Questions about Supply Chain Finance
What sets trade finance apart from SCF?
Trade finance encompasses a wide range of payment solutions for commercial transactions, including letters of credit issued by importers’ banks to guarantee payment upon meeting certain conditions, such as shipment of an order. On the other hand, supply chain finance is a type of trade finance that can reduce risk for the seller (exporter), but it is established and managed by the buyer (importer). Supply chain finance enables faster payment to the supplier while allowing the buyer to extend payment terms.
Is finance considered part of the supply chain?
Finance plays a crucial role in various aspects of the supply chain, which involves the movement of goods from one company to another. Suppliers need to invoice their buyers, and buyers need to make payments by a specified date. While the term “supply chain finance” may seem broad, it actually refers to a specific agreement where a buyer collaborates with a financial institution to facilitate early payment to suppliers for a fee, while often extending payment terms for the buyer.
What are the advantages of utilizing SCF?
Supply chain finance offers a multitude of benefits for both suppliers and buyers. Suppliers can enjoy accelerated cash flow, improved accuracy in predicting future income, and the avoidance of costly financing methods such as accounts payable factoring. Buyers, on the other hand, gain access to additional working capital as they receive extended payment terms from the financier. By helping to maintain financial stability among key partners in the supply chain, buyers can also reduce risk and strengthen relationships with suppliers, thereby earning greater negotiation leverage by offering faster payment options.
Why is SCF gaining popularity?
Supply chain finance has been gaining traction in popularity due to several factors. Firstly, in times of higher interest rates and tighter cash flow, supply chain finance becomes a more attractive financing option compared to other sources of capital. With the Federal Reserve raising base interest rates since early 2021, alternative financing methods have become more expensive. Additionally, inflation has led to reduced cash availability for many companies, with increased costs of goods and services. Furthermore, businesses have been stocking up on inventory to mitigate supply chain disruptions and uncertainties, resulting in higher expenses. In this context, supply chain finance has emerged as a viable solution to address these financial challenges.