What is Supply Chain Finance
Supply chain finance (SCF) is a set of technology-based business and financing processes that link the various parties in a transaction — buyer, seller and financing institution — in order to lower financing costs and improve business efficiency. Supply chain finance provides short-term credit that optimizes working capital for both the buyer and the seller.
Supply chain finance is also known as "supplier finance" or "reverse factoring."
BREAKING DOWN Supply Chain Finance
Supply chain finance utilizes business solutions that optimize working capital and provide liquidity to businesses. Under SCF, suppliers sell their invoices or receivables at a discount to banks or other financial service providers, often called factors. In return, the suppliers get faster access to the money they are owed, enabling them to use it for working capital, while buyers generally get more time to pay. Instead of relying on the creditworthiness of the supplier, the bank deals with the buyer.
There are a number of SCF transactions, including extension of buyer’s accounts payable terms, inventory finance and payables discounting. SCF solutions differ from traditional supply chain programs to enhance working capital, such as factoring and payment discounts, in two ways:
- SCF connects financial transactions to value as it moves through the supply chain.
- SCF encourages collaboration between the buyer and seller, rather than the competition that often pits buyer against seller and vice versa.
For example, the buyer will attempt to delay payment as long as possible, while the seller seeks to be paid as soon as possible. Supply chain finance works especially well when the buyer has a better credit rating than the seller and can therefore access capital at a lower cost. The buyer can leverage this advantage to negotiate better terms from the seller, such as an extension of payment terms, which enables the buyer to conserve cash or use it for other purposes. The seller benefits by accessing cheaper capital, while having the option to sell its receivables to receive immediate payment.
A typical extended payables transaction works as follows. Let’s say company X buys goods from supplier Y. Y supplies the goods and submits an invoice to X, which X approves for payment on standard credit terms of 30 days. If supplier Y requires payment before the 30-day credit period, the supplier may request immediate payment (at a discount) for the approved invoice from company X’s financial institution. The financial institution will remit the invoiced amount (less a discount for early payment) to supplier Y. In view of the relationship between company X and its financial institution, the latter may extend the payment period for a further 30 days. Company X therefore has obtained credit terms for 60 days, rather than the 30 days provided by supplier Y, while Y has received payment faster and at a lower cost than if it had used a traditional factoring agency.
SCF generally involves the use of a technology platform in order to automate transactions and track the invoice approval and settlement process from initiation to completion. The growing popularity of supply chain finance has been largely driven by the increasing globalization and complexity of the supply chain, especially in industries such as automotive, manufacturing and retail.