Supply Chain Finance: Everything You Need to Know

Supply chain funding might sound similar to trade finance. Sometimes, they are grouped under the same umbrella, but they are two distinct types of finance options.

Trade financing is designed for a buyer who needs cash to purchase stock from a supplier. This involves working on a confirmed order basis. So, if you’ve got a purchase order from a customer, trade finance helps with getting the stock to fulfil that order. The goods can then be shipped as soon as possible and you won’t lose any money while waiting for your customer to pay.

Here are some other notable differences between the two: 
 

• In trade financing, funding between an importer and an exporter is usually handled by a bank. For SCF, an external supply chain financier will be involved in the transactions between buyers and sellers.

• Generally, trade financing is an agreement between a buyer and a bank. With supply chain funding, it’s an agreement between a buyer, supplier and financier. 

• SCF is based on invoices while trade finance uses other payment terms like a letter of credit for import-export transactions or bank guarantees for domestic payments.

• Trade finance is a type of loan or credit that a bank extends to a buyer. SCF is about funding the receivables based on invoices and a buyer’s creditworthiness. 

At the heart of SCF is the paradoxical relationship between buyer and seller. The former wants to hold off on payment for as long as possible to stop cash outflow, which can be kept in the business. The latter wants to receive payment on time so they can make their next move and not waste time chasing the buyer for payment.

In this scenario, the buyer decides to extend the working capital line by paying a supplier as late as possible. This has the benefit of more cash being available for the buyer. But the supplier probably wouldn’t consider these terms of trade ideal.

This is where a SCF platform would come in. Let’s look at an example of how it would run in practice: 

1. A computer and laptop retailer buys goods from a semiconductor manufacturer. The computer seller and semiconductor manufacturer enter into a financial agreement with each other and a supply chain financier. This involves the retailer agreeing with the financier to pay the manufacturer immediately and the retailer to pay the financier later. 
   
2. The computer company and the manufacturer’s transactions happen. Then, the manufacturer raises invoices for the computer company. 
   
3. The computer brand uploads the invoices into the cloud facility of the SCF platform.
   
4. Next, the manufacturer approves the invoices and gets them from the financier. The received payment is less invoice value than the financing charges for the quick settlement.
   
5. The financier returns to the computer company and gets back the money for the invoices on the actual due date of the invoices. Any charges from the SCF representative might need to be paid by the buyer or the seller. 

In other words, no loan has been granted. In the SCF model, it’s simply an extension of credit between the computer retailer and the semiconductor manufacturer. The retailer has control over cash outflow, while the manufacturer’s receivable time has dropped. 

According to Miguel Cassio, a researcher director at Gartner, supply chain finance is “one of the very few initiatives that is truly win-win between buyers and suppliers, meaning buyers want to increase their payment terms and they can do that using supply chain finance.”

He also said the benefit of extended payment is a godsend at a time when there is so much uncertainty in the supply chain industry with labor shortages and the political turmoil of Ukraine/Russia, Hamas/Israel and the semiconductor arms race between the US and China.

“You're also helping the suppliers, especially during these times, and everybody is concerned about the financial health of their suppliers, especially the small and medium suppliers that are the ones who are most at risk of going bankrupt.”

Another benefit to be aware of is that with SCF suppliers have access to lower interest rates and financing costs. It’s an advantage for small, start-up suppliers to be involved in the process with a large buyer that has a good credit rating and higher profitability.

So, suppliers won’t have to use their working capital for the financing and that allows them to lower cash outflow.

We’ve already spoken about the tension that exists between buyers and sellers. As part of an SCF deal, they are powering each other’s success, which can lead to long-term growth and innovation for each other. They are invested in improving each other’s processes, cash flow and profitability.

For example, a large buyer may help a supplier enhance the overall quality of their products. Or the supplier could help by introducing new initiatives and suggestions for the buyer. 

There is a good case for coming up with a supply chain financing strategy. But there are risks too, like being able to access financing in the first place and the industry complexity.

A complex situation we need to address is this - there’s a paradox between manufacturers relying heavily on SCF, but still feeling confident about cash flow. We noticed in our research that 86% of manufacturers feel confident with their cash flow to pay suppliers in the next 12 months, but that many will keep on relying on SCF for the cash flow.

This suggests that SCF is being used as a crutch for some businesses whose cash flow isn’t stable. And in this paradox, we’d caution you because the more finance you take on, the higher your debt becomes. 

Following on from our previous point, a lack of standardization is a cause for concern with SCF. On one hand, businesses might be tempted to abuse it and continue to delay paying suppliers for as long as possible. For example, a construction company on the brink of collapse could try and take advantage of its vendors to flatter its own cash flow and prop itself up to delay the inevitable.

We’re not staying you’d do something like this. But a brand that gets caught will likely suffer from harsh backlash among suppliers, customers, media and investors. 

Good credit data makes all the difference in the world when applying for SCF. It’s data like average DBT, monthly DBT variation, past due payments, total amount owed, legal filings etc. This information will be scrutinized heavily by financers and if the data is poor quality then you’re unlikely to get the funding you want.

The quality and security of your data counts too. This is duplicate data, invalid information and conflicting financial metrics. Failing to get this right means you’re wasting even more money and time trying to fix those issues and that’s not a good position to be in if you’re already in debt.

Currently, there are no legal requirements for US companies to disclose SCF arrangements in regulatory filings. Because of this, some brands may decide to classify the arrangements as part of accounts payable, making liquidity positions seem stronger than they really are. 

The SEC is cracking down on this practice by encouraging companies to disclose any SCF arrangements so investors can make an informed decision. We suggest you adhere to their guidelines because when a business hides one thing, it suggests there’s more to find. Things like legal filings, court cases and high debt won’t do you any favors.

You should be as thorough with regulatory compliance as you are with supplier onboarding. This is creating a good working and payment process with all your suppliers and shows that you value their financial wellbeing. If onboarding is poor, then you’ll damage your reputation and make it harder to bring in new suppliers and customers in future.