SCF is the business finance strategy that goes beyond improving cash flow and efficiencies between buyers and suppliers involved in commercial transactions. It is how an organization applies technology to enable its supply chain partners to accelerate invoice payments while optimizing working capital for all those involved in the supply chain. This article may dissect supply chain finance and how it operates and discuss practically all the benefits it offers to a business organization.
What Is Supply Chain Finance?
Supply chain finance refers to a set of financial practices and tools that help us optimize the cash flow and manage the working capital needs of businesses within a supply chain. Putting cash transactions in line with supply chain processes allows suppliers to receive early payment of invoices and payment extensions for buyers. This concept is called 'supplier finance' or 'reverse factoring.'
The goal of supply chain finance is thus to boost the financial throughput and stability of both suppliers and buyers. Such financing can be tied to the buyer's credit rating, giving suppliers access to funds faster and cheaper. In return, this gives buyers longer terms for the payment of the goods without unsettling supplier relationships.
How Does Supply Chain Finance Work?
It is very much of the essence that organizations understand how supply chain finance works for their optimization of cash flow. Supply Chain Finance relates to finance on behalf of the buyer or seller, a financial institution, or a bank. This is how supply chain finance works in steps:
1. Order Placement
It starts when the buyer places an order with the supplier. The payoff conditions and delivery schedules would be agreed upon in these cases.
2. Invoice Issuance
The supplier will invoice the buyer when the goods or services are performed. The amount is due to be paid by the buyer to the supplier.
3. Invoice Approval
The buyer reviews and approves the invoice as evidence of goods or services received. This approval is very important because it commits the buyer to pay the invoice when it is due.
4. Early Payment Request
The supplier is now seeking financing to effect 'early' payment and consequently demands it from the third-party financier. The financier bases its decision for an affirmative response on the buyer's creditworthiness.
5. Financier Payment
Upon grant, the financier pays the supplier the invoice amount minus a small charge for early payment. This now immediately gives the supplier access to this money and frees up his liquidity.
6. Buyer Payment
On the due date of the original invoice, the buyer pays the entire amount to the financier. The borrower obtains extended payment terms and maintains a good relationship with the supplier.
Supply Chain Finance Process
The supply chain financing process integrates financial transactions and supply chain operations. Several key steps include:
1. Purchasing Order Issuance: The buyer issues a purchase order to the supplier indicating the goods and services needed along with the payment method.
2. Delivery of Goods/Services: The supplier delivers the goods or services ordered.
3. Submission of Invoices: The supplier sends an invoice to the buyer for verification and approval.
4. Invoice Endorsement: The buyer endorses the invoice, having satisfied itself regarding the receipt of the goods and/or services purchased.
5. Request for Early Payment: The supplier requests the financier for early payment based on the buyer's creditworthiness.
6. Disbursement by Financier: The financier pays the supplier after deducting service charges from the total payment.
7. Buyer Payment: At the time of the primary due date of the invoice, the buyer remits the payment to the financier.
Examples of Supply Chain Finance
For better understanding, let us see some real-life examples that will help in comprehension of this concept:
Example 1: Manufacturing Sector
A giant automobile company has a plethora of suppliers from where it will source its parts. Suppliers would like to receive an early payment of their invoices to strengthen their cash flows. The car company chooses a bank to facilitate the supply chain finance with its supplier networks. In effect, it extends credits to the manufacturers, based on which it would disburse funds to the suppliers. The bank has to assess the manufacturer's creditworthiness to extend the credits. In contrast, according to invoice management, the manufacturer pays back to the bank in due course on the original due date; this helps suppliers get instant money infusion into their business and guarantees that cash will flow at all times.
Example 2: Retail Industry
A supermarket collects a considerable amount of products from various suppliers. However, due to the long payment terms with the superstore, the suppliers usually experience cash flow insufficiency. But so far, supply chain finance has implemented an arrangement where a retailer pays suppliers early for their invoices, thus improving suppliers' liquidity position. Credit from a retailer may be termed as delayed payment terms from the relationship it never bore on suppliers.
Example 3: Technology Sector
A tech company needs different parts from suppliers to manufacture its products. The tech company has approached a financial institution to provide supply chain finance solutions to improve supplier relationships and ensure that those parts may be ordered efficiently. This means that when a supplier sells to the tech company, they get paid before the due date, but according to the tech company's credit rating. Therefore, the tech company can have extended payment terms for the components that may be required. This brings all the necessary resources to create a steady supply stream so that components can be added seamlessly into the supply chain.
Benefits of Supply Chain Finance
Supply chain finance solutions offer numerous benefits for both buyers and suppliers:
Supply chain finance is a powerful financial instrument that uses businesses in a supply chain to improve working capital and optimize cash flow. SCF uses technology and collaboration with the buyer, supplier, and financier- to financier- to create value for every stakeholder involved. The significant benefits include better cash flow, reduced financing costs, improved supplier relationships, increased operational efficiency, and risk mitigation, making it an increasingly important strategy for modern businesses.
Frequently Asked Questions
1. Is there another name for supply chain finance?
Most people regard supply chain finance as an alternative term for supplier finance or reverse factoring. These terms refer to the same financing solutions that cause invoices to be submitted and paid to suppliers before the due date. Supply chain finance is, in fact, the most popular term.
2. What’s the difference between supply chain finance and factoring?
In traditional factoring, the supplier sells their receivables to a financial institution, which collects payment from the buyer. In supply chain finance, the buyer approves invoices for financing, and the financier pays the supplier early based on the buyer's credit rating, with the buyer repaying the financier on the invoice due date.
3. How do I choose a provider for supply chain finance?
Factors such as the provider's reputation and the cost of financing, ease of integration with current systems, and level of support should be weighed before choosing a provider for supply chain finance. You must select a provider that listens to your requirements and develops tailor-made solutions to optimize supply chain operations.
