Supply chain finance (or SCF) is a form of supplier finance in which suppliers can receive early payment on their invoices. Supply chain finance reduces the risk of supply chain disruption and enables both buyers and suppliers to optimize their working capital. It’s also known as reverse factoring.
Unlike other receivables finance techniques like factoring, supply chain finance is set-up by the buyer instead of by the supplier. Another key difference is that suppliers can access supply chain finance at a funding cost based on the buyer’s credit rating, rather than their own. As a result, suppliers are typically able to receive supply chain finance at a lower cost than they can otherwise access.
The term ‘supply chain finance’ is also sometimes used to describe a broader range of supplier financing solutions, such as dynamic discounting, in which the buyer funds the program by enabling suppliers to access early payment on invoices in exchange for a discount. However, the term is more commonly used as a synonym for reverse factoring.
How does supply chain finance work?
In the first instance, the buyer will enter into an agreement with a supply chain finance provider and will then invite its suppliers to join the program. Some supply chain finance programs are funded by a single bank or finance provider, while other programs are run on a multi-funder basis by technology specialists via a dedicated platform.
While buyers have traditionally focused on onboarding their 20 or 50 largest suppliers, technology-led solutions now enable companies to offer supply chain finance to hundreds, thousands or even tens of thousands of suppliers. This is made possible by providing user-friendly platforms and streamlined supplier onboarding processes which makes it simple to onboard large numbers of suppliers rapidly and with minimal effort.
Once a supply chain finance program is up and running, suppliers can request early payment on their invoices.
Supply chain finance process
Buyer purchases goods or services from the supplier
Supplier issues their invoice to the buyer, with payment due within a certain number of days (e.g. 30 days, 60 days or 90 days)
Buyer approves the invoice for payment
Supplier requests early payment on the invoice
Funder sends payment to the supplier, with a small fee deducted
Buyer pays the funder on the invoice due date
Where accounting treatment is concerned, buyers which implement supply chain finance programs will need to make sure supply chain finance is classified as an on-balance sheet arrangement, rather than bank debt.
Benefits of supply chain finance
Suppliers and buyers can benefit from supply chain finance in many different ways:
Benefits for suppliers
Optimize working capital. By accessing supply chain finance, suppliers are able to receive payment for their invoices earlier than they would otherwise. As a result, their days sales outstanding (DSO)is reduced, resulting in working capital improvements.
Access lower cost funding. The cost of funding is usually lower for suppliers than it is if they use other sources of funding, such as factoring, making supply chain finance an attractive way of obtaining funding.
Improve cash forecasting accuracy. When suppliers access supply chain finance, they may gain more certainty over the timing of incoming payments, making it easier to forecast their future cash flows accurately.
Benefits for buyers
Optimize working capital. Buyers can also improve their working capital position with supply chain finance, as many companies choose to implement supply chain finance programs in conjunction with an initiative to harmonize supplier payment terms.
Improve supply chain health. By offering suppliers supply chain finance, buyers can reduce the likelihood of a future supply chain disruption that could affect their own operations.
Strengthen supplier relationships. Buyers can improve their relationships with suppliers by providing them with access to low-cost funding, and may be in a stronger negotiating position as a result.
While supply chain finance and dynamic discounting are two separate solutions, some companies may wish to access both types of program. For example, some businesses will have surplus cash available at certain times of the year, which can be deployed in a dynamic discounting program – but at other times of the year they may wish to invest cash elsewhere.
One option is to implement two separate solutions from different vendors – but this may be less than ideal in terms of the supplier experience. Alternatively, vendors which offer a flexible funding model may allow buyers to switch seamlessly between the two models as the need arises.