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Industry articles often tout benefits such as stronger buyer-supplier relationships for supply chain financing. But how do these perks hold up in practice?
Supply chain finance (SCF), a strategy used to optimize working capital, has gained popularity in recent years. In 2021, the global supply chain finance market generated $6 billion, and supply chain finance volumes increased by an estimated 38% from 2020.
Supply chains have been incentivized to reduce liquidity pressures since the rise of COVID-19 — but supply chain finance has also proliferated due to new fintech solutions aimed at automating transactions, decreasing costs and increasing efficiency for both buyers and suppliers.
If you’re an enterprise buyer, supply chain financing might seem like an attractive option for strengthening your supplier relationships through early payment while improving working capital. However, not all supply chain financing approaches are created equal. As SCF usage increases across global industries, certain myths about the practice have also emerged.
Here’s a closer look at how supply chain financing works and some common misconceptions that you might have about it.
Supply chain finance, also called reverse factoring, is an agreement that uses a third-party lender to help buyers and suppliers improve access to working capital. As an enterprise buyer, you most likely wait as long as possible to pay your suppliers’ invoices — even negotiating longer payment terms with them — to optimize working capital. Your suppliers optimize working capital by doing the opposite. For them, reducing days sales outstanding (DSO) increases cash flow. Supply chain financing addresses both these needs: a lender funds early payments to your suppliers and you pay back the balance later, according to your agreed terms.
In a supply chain financing program, a buyer partners with a financing provider, either a bank or a fintech company. When the buyer purchases from a supplier, the supplier delivers on the purchase order and submits an invoice. Then, the supplier receives early payment from the buyer’s lender in exchange for a discount. The buyer must then pay the lender the full invoice amount within the agreed term. The lender profits from the discount amount — the difference between what it pays the supplier versus what it receives from the buyer.
There are a few things to keep in mind with SCF. First, the payment terms between the buyer and the financing provider aren’t necessarily the same as the buyer-supplier payment terms. In most cases, the SCF agreement extends the payment period beyond the typical 30 days. Additionally, the lender judges financing eligibility based on the buyer, not the supplier, making SCF ideal for riskier suppliers with higher interest rates than their buyers. Lenders also determine the discount amount given by the supplier, and suppliers are obligated to receive early payment for all invoices.
In reality, the vast majority of suppliers can’t participate in supply chain finance programs offered by their buyers. This is because most suppliers have existing financing arrangements that prohibit them from delivering the complex paperwork required for traditional SCF programs through a bank.
For example, suppliers typically must provide receivables purchase agreements, company formation documents, lien releases, incumbency certificates, bank information verification and supplier setup forms as part of the onboarding process. SCF programs may also be inaccessible to suppliers because:
Complex capital structures prohibit their participation.
The onboarding process is too resource-intensive and costly.
Buyers may have minimum spending or location restrictions that prevent suppliers from qualifying.
Buyers can present win/lose terms to suppliers with unaffordable discount rates.
Purchase-to-pay systems used by buyers often already offer an early payment solution.
Sustainable funding sources are often hard for buyers to secure.
As a result, many SCF programs exclude small to mid-sized suppliers. Traditional supply chain financing is usually only accessible to a buyer’s top suppliers, even though these suppliers tend to be more financially secure and less likely to benefit from SCF.
Because traditional SCF programs are typically only available to top-tier buyers and suppliers, non-banking financial institutions and fintech companies have emerged to fill industry gaps. Many of these companies aim to simplify and expedite supplier qualification and onboarding processes.
Some also combine supply chain finance with early payment solutions such as dynamic discounting. For example, C2FO’s Dynamic Supplier Finance (DSF) blends dynamic discounting with funding from trustworthy financial partners. This means you and your suppliers can avoid the complex onboarding processes typical of SCF programs offered through banks. The dynamic discounting component also benefits your suppliers more than traditional SCF, allowing them to set discount rates and choose which invoices to accelerate.
The result is a more flexible, win-win solution: You preserve your working capital and pay suppliers early on terms that benefit both parties.
In theory, supply chain financing is meant to optimize working capital for both buyers and suppliers, strengthening the supply chain. In practice, buyers may use supply chain financing as a unilateral tool to extend payment terms with suppliers. According to Gartner, some supply chain finance terms extend payment obligations past industry averages (which range from 90 to 120 days) to 365 days. Mainstream financial analysts label this practice “bad reverse factoring.”
It’s easy to see how this arrangement can quickly sour buyer-supplier relationships. If a buyer uses SCF as leverage for longer payment terms, the supplier will most likely feel forced to accept a fixed discount to build the cash flow needed to stay in business. This can not only create regulatory and reputational issues for the buyer but also fracture relationships and weaken the entire supply chain.
This isn’t to say that all supply chain finance is bad for buyer-supplier relationships. Solutions with mutually beneficial terms, including those based on nontraditional supply chain finance technologies, can help build win-win, long-term relationships for more resilient supply chains.
It’s true that nontraditional supply chain finance solutions use technologies, such as blockchain and AI, to simplify implementation. However, traditional SCF programs delivered through banks are still complex and time-consuming to initiate, even if they are starting to digitally transform. These programs can take as long as six months to launch and, in some cases, require participating companies to dedicate several employees to the project.
If you are implementing a supply chain finance program through a large financial institution, you should be aware that it’s likely to require extensive paperwork and cost a significant amount of time and resources for all parties. Again, this is why only your largest, most strategic suppliers may be on board, leaving behind smaller suppliers — the ones that would probably benefit from early payment the most.
If your goal is to include more of your suppliers in a supply chain financing program, consider alternatives that are designed to minimize onboarding resources. Solutions that give suppliers more flexibility, such as dynamic discounting, can also reduce SCF barriers in your supplier network.
This may have been true a few years ago. But now, a variety of fintech and non-bank lenders are catering to companies that want to accelerate supplier payments without navigating the exclusionary, arduous processes of traditional SCF.
Solutions such as C2FO’s Dynamic Supplier Finance program, for example, give you, the buyer, the option of funding early payment either through your working capital or a third-party network of funders. A more diverse alternative like this has several advantages over traditional SCF:
Suppliers determine acceptable discount amounts as well as which invoices to request early payment on, giving them more agency in the transaction.
Easy implementation, competitive pricing and flexibility of use make it accessible for small, medium and strategic suppliers alike.
Combined, these benefits yield more supplier participation to create a stronger, more reliably funded supply chain.
Global supply chain disruptions in recent years have generated a spike in supply chain financing volumes as more companies seek better working capital access for themselves and their suppliers. However, traditional supply chain financing often uses outdated processes, terms and onboarding infrastructure — and buyers typically only target their largest suppliers with SCF programs.
Thankfully, alternative lenders and fintech solutions are helping suppliers of all sizes see mutual benefits from supply chain finance. A closer look at the myths surrounding SCF shows that the practice doesn’t always mean better working capital access for both parties, stronger buyer-supplier relationships or easy implementation. However, your enterprise can realize these advantages by leveraging more innovative supply chain finance solutions.
Looking for a more inclusive supply chain finance solution? Learn more about Dynamic Supplier Finance.
This article originally published August 2020, and was updated December 2022.
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Understand the differences and similarities between reverse factoring and supply chain financing so you can find a solution that fits your business’s needs.
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