What is supply chain finance?

Supply chain finance (SCF) refers to a set of solutions that optimize the management of working capital across supply chains. It encompasses financing and risk mitigation practices and techniques that aim to lower costs and improve efficiency for buyers, suppliers, banks, and other parties involved in supply chain transactions.

In recent years, supply chain finance has gained significant traction among companies as a way to access affordable financing, improve cash flow, and strengthen supply chain relationships.

What is Supply Chain Finance?

Supply chain finance is an umbrella term for a range of financial products and services that aim to lower the working capital requirements and improve the cash flows of companies involved in supply chain operations and transactions. It enables both buyers and suppliers to better manage cash flow while also providing access to financing at more favorable rates compared to traditional forms of financing.

Specifically, SCF refers to financing solutions involving a third party – typically a bank or other financial institution – that facilitates financing for suppliers based on the creditworthiness of the buyer. This allows high-quality buyers to extend their superior credit rates to their suppliers, enabling suppliers to lower their financing costs. As such, SCF solutions are beneficial for buyers, suppliers, and banks alike.

The goal of supply chain finance is to inject liquidity into the supply chain in the most optimal way possible in order to ensure efficiency of operations, timely payments, uninterrupted production cycles, and overall supply chain stability. Implementing appropriate SCF solutions allows businesses to effectively bridge the gap between when expenses are incurred by suppliers for production and when revenue is realized after delivery to buyers. This bridging of the cash conversion cycle enhances firms’ working capital position.

Common Types of Supply Chain Finance Programs

There are several common types of SCF programs and techniques offered by banks and other financial intermediaries. Each program works differently and serves distinct business purposes.

The main types are:

1. Receivables Discounting – This involves a buyer receiving early payment on their invoices from the bank by having suppliers discount invoices due with the financial institution. Suppliers receive early payment from the bank on approved invoices and the buyer later pays the bank on longer terms. This improves the cash position for both suppliers and buyers.
2. Payables Finance – Here, the suppliers receive financing from the financial institution for approved invoices due from the buyer. The bank provides an early payment to the supplier based on the creditworthiness of the buyer. The buyer later pays the bank on the actual due date based on original payment terms agreed with the suppliers. This helps suppliers receive working capital financing at more favorable rates.
3. Distributor Finance – In this arrangement, financing is provided to distributors based on invoices generated to end buyers. Distributors can receive early payment on approved invoices by having the bank pay them the amount due from customers. The customers later pay the bank based on the original invoice due dates. This improves liquidity for distribution intermediaries.
4. Dynamic Discounting – Buyers offer suppliers short term discounts on invoices if they are willing to accept early payment. Suppliers waiting until actual due dates pay receive full invoice amounts, while early payment comes with applicable discounts that reduce the amount owed.
5. Inventory Finance – Banks provide working capital financing using the value of inventory as collateral. Borrowers may include manufacturers, distributors, wholesalers, dealers, retailers or traders. Inventory finance helps them raise working capital to run operations.
6. Purchase Order Financing – Financing against purchase orders helps suppliers secure working capital needed to fulfill confirmed orders from creditworthy buyers. Suppliers can access financing as soon as they receive the purchase order to cover production and fulfillment costs.

The specific type of SCF program suited for a supply chain depends on the sector, market environment, depth of supply chain relationships as well as internal priorities and objectives for buyers, suppliers, and banks. Banks can customize programs accordingly based on the dynamics involved.

Key Steps in the Supply Chain Finance Process

The typical supply chain finance solution utilizes a collaborative approach that brings buyers, suppliers, and financial institutions together on a common platform. While each SCF program has its unique attributes, most forms of supply chain finance follow this general workflow:

1. Buyer places purchase orders with suppliers as per usual procurement practices
2. Suppliers produce goods and issue invoices to buyers for goods delivery
3. Suppliers or buyers elect certain approved invoices to be considered for early payment under pre-agreed SCF programs
4. Invoices and key details are uploaded onto the SCF platform by relevant stakeholders
5. The financial institution reviews selected invoices based on predefined criteria and makes early payment to suppliers at a discount or to buyers for approved invoices
6. On due dates, buyers make payments to the financial institution as per original terms
7. The SCF provider earns a return for financing and facilitating early payments
8. Additional value-added services like supply chain analytics may also be provided on the platform

This streamlined, collaborative workflow powered by SCF ensures that working capital bottlenecks do not jeopardize production schedules, inventory stocks, or fulfillment capabilities. The enhanced liquidity allows suppliers to optimize operations while buyers can take advantage of favorable commercial terms including discounts for early payments.

Key Benefits of Supply Chain Finance

Supply chain finance delivers tangible advantages for all main stakeholders, including:

For Buyers

• Lower procurement costs – Discounts can be availed for early payments
• Improved supplier relationships – Better liquidity ensures reliable deliveries
• Enhanced supply chain resilience – Suppliers avoid disruptions from cash issues
• Higher-quality goods – Suppliers invest in better inputs
• Deeper visibility into supply chain – Analytics provide greater transparency

For Suppliers

• Improved cash flows – Early access to working capital at favorable rates
• Better capacity utilization – Production planning is optimized
• Less administrative burden – Streamlined documentation and processing
• Strengthened buyer relationships – Reliability of supply increases appeal
• Higher revenue and profits – Expanded production capacity enables growth

For Banks/Financial Institutions

• Attractive interest income – New financing products expand offerings
• Increased transaction volumes – Processing multiple early payment requests
• Cross-selling opportunities – Optimized client engagement channels
• First-mover advantages – Capture untapped markets
• Risk mitigation – Exposure spread across diversified supply chains

The incentive to collaborate through SCF solutions is clear for buyers, suppliers, banks, and other intermediated. Efficiency is enhanced, costs are lowered, profits are bolstered, risks are minimized, and working capital positions are elevated for all parties when supply chain finance programs work as designed.

Conclusion

Supply chain finance is steadily transitioning from a niche offering to a mainstream value-driver for supply chain relationships, operations excellence and working capital optimization. Backed by advancing fintech capabilities and supported by a conducive regulatory push, SCF solutions are delivering quantifiable efficiencies, risk mitigation, and costs benefits for participants.