Blog by Andrew Coles, Head of Solution Consulting, Surecomp

Late payments and cash flow bottlenecks are two of the most significant factors behind supply chain breakdowns and poor supplier performance. Not only can they damage supplier-buyer relationships, but they can also affect other supplier relationships along the chain, causing disruption and incurring financial costs in the form of expensive late payment penalties.

Supply chain finance helps to ease such issues, enabling stronger and more efficient supply chains for everyone involved.

What is supply chain finance?

In simple terms, supply chain finance (also known as reverse factoring or approved payables finance) is a financing technique that gives suppliers the ability to receive early payments on their invoices. It is ultimately about facilitating the movement of capital to help manage risk across the chain while limiting disruption and streamlining transactions.

How does supply chain finance work?

A responsible supplier will have contractually stipulated an exact date by which the invoice needs to paying. Simple right?

Not entirely; the truth in the real world is that many buyers cannot and do not initiate supplier contracts with available funds already in the bank. Many secure contracts are based on projected earnings before the invoice due date, or experience unforeseen circumstances that might obstruct a portion (or all) of the funds set aside for the supplier. While the supplier and buyer can often resolve these situations if the supplier and buyer have a good relationship, it still presents a cash flow problem for the supplier. It puts buyers into positions of debt with businesses that aren’t built to handle them.

Supply chain finance (SCF) functions by installing a bank or other financial institution as the third party in charge of managing transactions between suppliers and buyers, and the effect is two-fold:

1. Helping buyers settle supplier payments on time

When buyers cannot pay their suppliers in the required period stated on the invoice, the bank – the cash and credit-rich party – will pay the supplier on behalf of the buyer. When this is the case, the buyer’s debt will shift from the supplier to the bank, where the buyer and the bank must negotiate the terms upon which the buyer will settle the debt.

2. Keeping supply chains moving

Supply chain finance also keeps the supply chain moving and functional for suppliers. Having multiple active contracts at any given time naturally increases their exposure. Relying on invoice due dates and the credit of active contracts to make cash flow projections and secure future deals is a risky business. If multiple buyers delay payment, it can disrupt operations, damage trade relations and impact working capital.

To minimise pressure and reduce friction in the supply chain, SCF ensures suppliers have a greater degree of assurance that their invoices will be paid on time, optimising liquidity and cash flow forecasting.

Why is supply chain finance important?

At the heart of it, supply chain finance is about ensuring that both parties can meet their obligations with certainty and trust. The financial benefits are clear for the supplier, and the flexible payment terms keep buyers out of trouble.

Benefits for the supplier

It should be noted that supply chain finance doesn’t just benefit suppliers when it’s time to invoice. Many financial institutions will allow suppliers to be paid early in exchange for a reduced fee (known as dynamic discounting). This can often help suppliers who would otherwise rely on deposits or leverage their businesses to another bank to secure the product they would eventually supply to the buyer.

Benefits for the buyer

To secure finance, you as a buyer will need to prove to the lender that your business is healthy enough for them to make the payment on your behalf. Guaranteeing that you can then subsequently meet your payment obligations to the lender, in turn, generates supplier confidence. Many markets rely on reputation and investor trust, and the stamp of approval from a major financial institution creates confidence and strengthens vital relationships.

Benefits for the bank

An extra revenue stream for the bank, supply chain finance is predominantly a short-term agreement representing a low risk of default. Covered under Basel rules, SCF funds are uncommitted, which means that the bank is only regulated according to what is lent, rather than the whole credit limit provided to the buyer.

Efficiency gains from digital processing

Given the importance of navigating supply chain intricacies and the apparent benefits of supply chain finance, we turn to the use of technology to optimise working capital and operational efficiency.

SCF is a relatively new concept, and as such, has been able to bypass much of the legacy paper-based processing and go straight to digitisation. SCF platforms form a hub that brings together the lender, buyer and supplier for the accessibility, visibility and digital processing of the contract and invoicing data in a time and cost-efficient manner.  For example, APIs allow the extraction of invoice data directly from the buyer’s sales ledger without needing to be re-keyed. This can then be presented to the parties involved both online and on mobile devices. Once requested, funds can be processed against a set of predefined rules and automatically authorised without the need for manual verification. This reduces both elapsed time and costs, which in turn result in lower fees to the customer.

Our supply chain finance solution is a standalone module available within DOKA-NG, our flagship back-office trade finance processing software. Highly configurable, the SWIFT-certified technology integrates easily with existing back and front-office environments for seamless financing process optimisation. Automating key SCF processes, handling approved payables financing (reverse factoring) and receivables financing, the SCF module monitors risk exposure, filters invoices by eligibility criteria, and provides flexibility with charging interest and fees.