Supply chain finance, also known as supplier finance or reverse factoring, is a financing solution 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.
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 with other financing methods.
The term supply chain finance is also sometimes used generically to describe a broader range of supplier financing solutions, including solutions like dynamic discounting, in which the buyer funds the program by enabling suppliers to access early payment on invoices in exchange for an early payment 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, financial institution or alternative 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 across a global supply chain. 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. From there, the supply chain finance process plays out, which typically looks something like this:
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 who 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.
Supply chain finance example
To make things a little clearer, let’s look at a hypothetical example of a supply chain finance solution in action.
A buyer purchases an order of goods from a seller. Typically, the supplier would ship the goods to the buyer, then submit an invoice under their payment terms (of, let’s say, net 30). That would leave the buyer with 30 days to pay their invoice.
However, if the supplier wants their invoice paying faster (or the buyer doesn’t have the cash available or would rather keep hold of it to use as working capital), they can utilize an existing supply chain finance solution. This then implicates a third party – the financer or lender – who will pay the invoice immediately on behalf of the buyer and then extend the payment terms on which the buyer must pay them back, perhaps to 60 days.
This is a win-win situation, the buyer gets to keep hold of their working capital for longer without spoiling their relationship with the supplier, and the supplier gets to be paid immediately giving them more working capital of their own to deploy. There are plenty of other benefits, too.
Benefits of supply chain finance
Both suppliers and buyers can benefit from supply chain finance in many ways:
Benefits for suppliers
Optimize working capital. By accessing supply chain finance, suppliers can 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 financing solutions from different vendors – but this may be less than ideal in terms of the supplier experience. Alternatively, vendors that offer a flexible funding model may allow buyers to switch seamlessly between the two models as the need arises.
Supply chain finance is a valuable tool in any company’s working capital optimization arsenal. It helps buyers to improve their working capital position while maintaining strong supplier relationships by involving a third-party factor to pay invoices early. It’s also important to suppliers, as they can access capital early without having to extend their own line of credit, meaning they can benefit from their buyer’s credit rating rather than their own.
Supply chain finance is also known as reverse factoring and is differentiated from regular factoring by one key detail. Under a factoring arrangement, it’s the supplier who initiates the funding process by selling their invoices to a third-party factor, who the buyer later pays in-line with the original payment terms. In reverse factoring, it’s the buyer who initiates by requesting the factor pay the supplier. This means that factoring involves the supplier drawing on credit, while in reverse factoring it's the buyer’s credit rating that’s important.
Supply chain finance is offered by diverse financial institutions, from banks to dedicated supply chain finance providers like Taulia. Choosing the right provider for you is a personal process, but there are some considerations to make as you choose, including the size of business they typically service, how flexible they are, how well their solution fits into your existing ERP, and how large their existing network of suppliers is.