With modern supply chains being globally interlinked with many parties involved, payment terms can be overly extensive, causing cash shortages for buyers and sellers alike. Working capital becomes tied up in the supply chain until invoices are processed. Buyers want better payment terms from suppliers and suppliers want better payment terms from buyers. This push and pull of competing objectives can cause a supply chain to grind to a halt.
Supply chain finance helps alleviate this tug-of-war between suppliers and buyers. In this article, you'll learn how supply chain finance improves supply chain workflows through better financial payment terms for suppliers and buyers alike.
Supply Chain Finance Overview
Buyers want the best payment terms possible from suppliers. This means requesting credit extensions, allowing them to pay their invoices at a later date, which could be 90 days (net 90). By delaying payment, buyers are able to utilize working capital for other growth endeavors since cash isn't going toward paying invoices. The longer a buyer can extend supplier invoices past the buyer's customer invoice due dates, the more working capital buyers will have.
All of this comes at the supplier's expense. Just like buyers, suppliers have bills to pay as well. If most of a supplier's bills are due within 60 days and customers are paying 90 days after receiving an invoice, there's a 30-day gap that the supplier will have to finance. Financing this gap can be costly since it incurs interest charges and potentially loan origination fees.
To get around this problem, suppliers utilize a supply chain finance program. For a fee, the program will pay the supplier the amount of any outstanding invoice once it is approved by the buyer. This is a form of reverse factoring. In this scenario, the buyer benefits because they received extended credit and suppliers benefit because they have additional working capital.
For both the buyer and seller, there is no impact on their balance sheets. Supply chain finance is not a loan, early payment or invoice factoring.
How Supply Chain Finance Works
Supply chain finance has two components:
- Buyers receive extended invoice due dates. This can be double the original length of time.
- Suppliers extend credit to buyers and receive payment on their approved invoices.
While the above steps may seem a little disjointed, the entire process is coordinated on the buyer's side. The buyer facilitates supply chain finance with a software platform from a vendor that specializes in supply chain finance. The buyer identifies suppliers that are candidates to participate in the program. Once suppliers have been identified, the buyer sends an invite to participate in the program. When a supplier accepts, they are on-boarded. On-boarding can be very elaborate for buyers but must be done right to ensure suppliers will complete the process and become participates in the program.
Once a supplier has completed on-boarding and joined the program, they issue invoices to buyers based on revised payment terms. To compensate suppliers for unfavorable payment terms, lenders or funders provide early payment for outstanding invoices minus a small fee.
Once the process is complete, both the supplier and buyer have additional working capital. The buyer can pay outstanding invoices to the supplier or lender.
The supply chain finance process is highly coordinated and meant to ensure no one side has an advantage over the other. Both buyer and seller are fully aware of the process. They agree to participate to the mutual benefit of both sides.
The Benefits Of Supply Chain Finance
Supply chain finance offers companies a chance to grow. Especially smaller companies that are starved for cash. Working capital is the lifeblood of any business. Supply chain finance pumps in new working capital to all participants.
With suppliers being more vulnerable to economic shocks than other players within the supply chain, receiving early payment on invoices can help to absorb such shocks.
Without supply chain finance, some supply chain players may decide they have no option but to leave the supply chain. This may be due to unfavorable payment terms. Depending on the player's role, their departure can greatly upset the supply chain, causing delays and ripple effects further down the line. By offering such players a chance to participate in supply chain finance, multiple players can benefit due to the supply chain continuing to operate without disruption.
Supply chain finance can also help companies build stronger working relationships. By allowing players to stay within the supply chain, deals can be made that would otherwise have not been made if a key player would have left. Companies can work together with confidence. Innovative, long-term projects can be pursued knowing an important buyer or supplier will be around for the long haul. These types of relationships create stabilization and opportunities throughout the entire supply chain.
Global growth, stabilization, new opportunities and stronger relationships are the prime benefits of supply chain finance.