Supply chain finance is a way of providing liquidity to businesses. But what is it and why do it? How is it different from the more traditional approaches of factoring and invoice discounting?
To access working capital finance, businesses have traditionally used short-term trading assets such as stock or trade receivables, as security. From a lender's perspective, the most liquid of these assets – that most easily converted into cash - is the accounts receivable ledger. The lender will effectively secure their loan by using this asset as the primary collateral. The lenders repayment source is the collection of these accounts receivable directly from the end customer (i.e. the debtor).
Factoring is transactional by design, with the lender purchasing, and then directly taking over the collection, of each receivable. Even purchasing a single invoice is now common via peer-to-peer platforms.
Invoice discounting is a more wholesale arrangement. This is usually based on selling the complete debtor’s ledger whilst allowing the borrower to manage the receivable collection themselves.
Fluctuating funding: The amount of funding available at any point can vary tremendously. It is dependent on the invoices being funded and the lenders view on each end customer.
High fixed costs: Lenders typically earn most of their income through the application of fees rather than the interest rate on the funds lent. As such, these facilities can have a high fixed cost, especially when they are only used occasionally
High touch management: There is usually also a considerable time commitment from the borrower, with intrusive audits, reporting and disclosure requirements.
Sector specific: Whilst this is beginning to change, there are some sectors with few customer invoices (such as retailers, or sub-contractors in construction) where factoring and invoice discounting are not an option.
From the borrower’s perspective, factoring and invoice discounting look UP the supply chain to customers and use these debts as security.
Supply chain finance looks DOWN the supply chain to the suppliers. It is a form of working capital finance that provides liquidity in a similar way to an overdraft. The main difference being that funds are only used to pay suppliers.
Digital platforms: The adoption of digital funding platforms has notably increased, making the financing process more efficient and accessible. These platforms now offer advanced features such as slick user interfaces and real-time tracking, with some lenders such as TradeBridge, offering embedded supply chain finance to further increase benefits.
Broadening reach: These financial solutions are extending their reach both geographically, across global borders and into an increasingly diverse range of industries. This increasing reach broadens acceptance.
Enhanced flexibility: As market perceptions of non-traditional lenders improve, their flexibility – supported by technological advancements – also improves, driving increasing access to new markets and industries.
Adaptive growth: As the economic context becomes more complex, the demand for innovative and flexible funding solutions is anticipated to rise. These solutions are becoming crucial for managing cashflow and supply chain dynamics under fluctuating and sometimes volatile market conditions.
There are two broad types of supply chain finance in the market. They can be described as “supplier initiated” or “buyer initiated”.
Supplier-initiated programmes (this includes reverse factoring) allow suppliers to sign-up to the programme and request early payment on approved invoices before they are due. The supplier receives the early payment from the lender (less the finance fee) and the lender gets repaid by the borrower on the due date.
Buyer-initiated programmes (sometimes called payables finance or supplier finance) involve the buyer (or the borrower) instructing the lender to make payments directly to the supplier. These payments can be made early or on the due date. A fee is usually charged to the buyer who repays the lender on the agreed date (which may be after the due date).
In both cases, the facility unlocks cash from the business process, allowing the active management of cash flow and liquidity.
From the supplier's perspective, there are few downsides to being part of supply chain finance programme apart from the fee. Suppliers should just be aware that funding under a SCF programme, is never guaranteed and may be withdrawn with little notice (especially if the buyer strikes financial troubles).
From the buyer's perspective, detailed financial information (and sometimes security) is required. In addition, the SCF provider will often take out trade credit insurance against the buyer to cover their risk.
Few companies use supply chain finance for the sole benefit of their suppliers or to “secure the supply chain’ as it is sometimes put. In our experience, more common reasons to use supply chain finance include:
As with all areas of business, technology is driving change within the financing landscape. The evolution of digital platforms is addressing many traditional challenges. Complex issues such as global application, visibility and real-time reporting can be simplified with digital transformation.
On the forefront of this change are funders such as TradeBridge. Those who go one step further, to embed proprietary technology into client process, automatically extracting the data they need minimise touch, tailor solutions and support an intelligence led, partnership driven approach to funding.
Is Reverse Factoring Also Supply Chain Finance?
Reverse Factoring is a type of supply chain finance, typically practised between specialist banks and very large borrowers. It is called ‘factoring’ because to avoid the facility being classified as debt on the borrower's balance sheet, the bank must purchase the supplier’s invoice. A separate contract between the bank and the borrower covers the repayment obligations, which allows the lender to offer the borrower’s suppliers reduced pricing, based on the high credit rating of their client once the invoice is approved (hence “reverse”).
If this seems complicated, that’s because it is! It is usually done for one purpose only; to allow the larger company to borrow tens of millions $ without it being called “debt”.
TradeBridge is a non-traditional lender that creates new sources of working capital. We enable entrepreneurial business leaders to seize opportunity by using:
For more information on how we can help you seize your moment, contact us at tel:+ 44 20 7313 8088 today or eMail info@tradebridge.com