Supply chain finance explained

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Page written by Chris Godfrey. Last reviewed on October 19, 2024. Next review due January 1, 2025.

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More than half of Irish SMEs say poor cashflow is the biggest issue for their business. Slow payment for goods or services delivered is a common problem. As more of the world’s trade is dominated by huge corporations, and suppliers must accept their extended payment terms, it’s unlikely this situation will improve. Fortunately, there is a solution for those who wish to take it – step forward supply chain finance – the short-term, unsecured lending option that delivers a win/win for all: Suppliers get paid faster and save on fees. Buyers protect working capital and keep their trading partners happy. Supply chain financing – where everyone’s a cashflow king.

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What is supply chain finance?

Supply chain finance provides unsecured cash advances to the supplier(s) in a supply chain. It gets them paid early. This type of lending is also called ‘supplier finance’, but unlike traditional factoring or invoice-financing it’s cashflow positive for both buyer and seller – allowing suppliers to get paid sooner and buyers to extend the usual grace period before they must pay for the supplies they purchase. Because the finance is based on the credit score of the buyer, who are usually larger companies than their suppliers and who typically enjoy a stronger financial base, the fees that are paid by the supplier for receiving early payment are often less than they would pay with standard factoring or other forms of business finance. The buyer pays no fees in the transaction.

How does supply chain finance work?

Every transaction in supply chain finance is a co-operation between supplier, buyer, and lender. All parties benefit from the deal and the strength of the buyer’s credit is the transaction anchor. Because larger buyers are highly likely to honour invoices from their smaller suppliers, lenders tend to consider these bills a ‘safe bet’ and they will lend against the invoice value. This allows suppliers to receive 100% of the due sum as an advance from the lender, (minus a small fee), once the buyer has approved the invoice for payment.

The process works like this:

The supplier issues an invoice to the buyer
The buyer confirms that the invoice has been approved for payment to the lender
The supplier gets the full invoice value immediately – minus a small fee
When payment is due, the buyer pays the lender.

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What are the benefits of supply chain finance?

Pros

Supply chain finance is beneficial for both buyer and supplier.

For suppliers: The process is cashflow positive. Once the lender agrees to the transaction terms, the supplier usually receives 100% of the invoice value (minus a small fee) within a few days instead of waiting weeks or months for payment.
For buyers: It is possible to extend the grace period before they must pay for the supplies they purchase. This is also cashflow positive, as the buyer’s working capital remains untouched until the extended payment terms are over.

What are the disadvantages?

Cons

Pros and cons come with all finance arrangements. Key disadvantages of supply chain finance are:

Buyer weakness: Even though it is the supplier who receives the cash advance from the lender, supply chain finance is reliant on the credit score of the buyer. Should the buyer have a weak credit score, or they run into sudden financial difficulty, supply chain finance may not be possible.
Extended terms: Because the buyer ‘drives’ the transaction, they may seek opportunities to improve the deal on terms that are tilted in their favour – for example asking for very long payment terms (120 days or more), which will cost the supplier more in fees. (The longer the lender must wait to be paid back, the more they charge).

Supply chain finance example

AAA Engineering is an SME who provides finished components to Global Motors, a large multi-conglomerate. Global Motors purchases €1m of components from AAA. Normal payment terms are 60 days from the date of delivery. However, AAA must pay for raw materials and component parts in 30 days, and they represent 65% of the total deal value (€650,000). This means AAA will need to pay out €650k before they get paid by Global – a potential cashflow issue.

Global offers AAA the option of supply chain financing. A lender will make AAA an immediate cash advance of €1m, minus their fee, with Global Motors paying the lender back in 90 days. AAA accepts the deal.

This arrangement is a win/win for everyone, as it allows AAA to get paid before they must pay for the raw materials worth €650k, and thus avoid a cashflow crunch. It also allows Global the chance to extend their payment cycle from 60 to 90 days, reducing impact on their working capital.

How much does supply chain finance cost?

Because supply chain finance is effectively backed by the credit rating of the buyer, who is typically larger and with greater financial strength than their suppliers, the fees that lenders charge suppliers for financing are often less than for factoring and many other types of business finance. Note that deal terms may vary with each transaction, but in all cases, the following rules apply:

The more the lender finances, the greater the fee.
The longer the lender must wait to be paid back, the greater the fee.

What’s the difference between trade finance and supply chain finance?

Trade finance and supply chain finance are both designed to finance international and domestic supply chains, but they are not the same thing.

Trade finance: Trade finance is a generic term that has been in use for many years. It covers a broad range of financing products and solutions, including letters of credit, bank guarantees, commercial paper, and documentary collections. These products are typically used when trading partners do not know each other well, or at all, and they rely on the security of the goods in the transaction instead of the credit score of the buyer.
Supply chain finance: Supply chain finance is a newer form of financing and trade risk mitigation. Because it relies on the financial strength of the buyer and not on the security of the goods, it is far more likely to be used in relation to open account trade, where the buyer and seller know each other well, have done business together before and the buyer is confident that the supplier will deliver on time and in good order.

Is supply chain finance the same as factoring?

No. With traditional factoring, the supplier seeks to borrow against the value of its invoices to improve cashflow. The supplier sells their invoices to a lender (the ‘factor’) who takes control of the supplier’s sales book. This form of lending changes nothing for the buyer and because it relies more on the financial strength of the supplier, it can be expensive for some firms. Additionally, factoring will usually only provide up to 80% of invoice value as an advance. With supply chain financing, the buyer seeks borrowing to extend payment terms for the supplies it purchases. The supplier does not sell their invoices to the lender. The buyer pays nothing for this form of lending, but they offer their financial strength as security for the loans. This has the double benefit of improving cashflow for the buyer and the supplier, who receives payment much sooner and at a lower cost than factoring.

Dynamic discounting vs. supply chain finance

Dynamic discounting and supply chain finance are funding options that allow a buyer to support their top suppliers by making early payment of their invoices. However, they are not the same thing.

Supply chain financing: Supports cashflow for buyer and supplier. Uses bank or commercial lending to facilitate early payment of the supplier’s invoices, with the buyer offering their financial strength as security for the loans. The supplier cannot choose which bills receive financing and they pay a fee that is usually lower than they would pay with other forms of business financing.
Dynamic discounting: Supports cashflow for buyer and supplier. Uses the buyer’s surplus cash to offer early payment to their suppliers, who also pay a fee that is usually lower than they would pay with other forms of business financing. The supplier is not locked into this arrangement, and they can select which invoices are repaid early, and how soon they will accept repayment – the quicker they want the cash, the more they pay. This form of flexible financing allows the buyer to extend their payment terms for some bills and make extra money from their surplus cash. The supplier gains earlier payment and control over which bills to discount and how much they pay in fees.

Sustainable supply chain finance explained

Sustainable supply chain finance is a term used to define supply chain finance practices that support trade transactions with minimal negative impact and that create environmental, social, and economic benefits for everyone involved in bringing products and services to market.

Primarily led by large, international corporations and financed by a growing number of banks and commercial lenders, sustainable supply chain finance is attempting to reduce and eventually eliminate fraud, abuse of workers’ rights and destruction of the environment by rogue supplier companies and across global supply chains. One way that this is being pursued is by the offer of preferential supply chain financing to suppliers who can prove that they operate within the given boundaries of sustainable trade. This means they get paid sooner and at lower cost if they operate honestly, treat their workers with respect and do not engage in harmful environmental practices. Regular audits and digital tracing are used to ensure the supplier maintains their side of the bargain.

For the buyer, a successful outcome represents a double win: Firstly, it is cashflow positive as they can extend the grace period before they must pay their suppliers. Secondly, a clean and sustainable supply chain is a powerful marketing tool that resonates strongly with consumers. Organisations that can claim their supply chain is free from harmful practices will have a sales edge against competitors who cannot.

Unsecured supply chain finance explained

Unsecured supply chain finance is a financier’s term used to describe the lack of tangible security in a supply chain financing transaction. Unlike invoice-financing, factoring, or bank loans, supply chain financing does not place a lien, (or claim ownership) on any assets in the transaction – such as invoices, a company’s sales ledger, inventory, or hard assets such as property. Supply chain financing relies solely on the confidence that the buyer will pay a supplier’s invoice. Because there is no other collateral involved it is called ‘unsecured’ and it is always short-term lending.

How do I apply?

No matter if you’re a buyer or a seller, cash is king in business. Get paid sooner, pay bills later, take firm control of your working capital. Register your business with Swoop to discover more about supply chain financing and how to make your cash work harder for your company.

Written by

Chris Godfrey

Chris is a freelance copywriter and content creator. He has been active in the marketing, advertising, and publishing industries for more than twenty-five years. Writing for Barclays Bank, Metro Bank, Wells Fargo, ABN Amro, Quidco, Legal and General, Inshur Zego, AIG, Met Life, State Farm, Direct Line, insurers and pension funds, his words have appeared online and in print to inform, entertain and explain the complex world of consumer and business finance and insurance.

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