Supply Chain Finance (SCF)
Supply chain finance (SCF) refers to a collection of technology-based solutions to reduce financing costs and increase business efficiency for buyers and sellers involved in a sales transaction.
SCF techniques function by automating transactions and tracking the approval and payment of invoices from start to finish. Buyers agree to accept their suppliers’ bills for financing by a bank or other outside lender, referred to as “factors” in this paradigm. SCF also benefits all participants by providing short-term loans that optimize working capital and liquidity to both parties. Buyers receive a longer time to pay off their accounts, while suppliers get faster access to the money they owe. The parties can utilize the cash on hand for additional initiatives to keep their respective operations running smoothly on either side of the equation.
How does it work?
Step 1: Buyer purchases goods or services from the seller. It is preferable when the buyer has a better credit rating when compared to the seller.
Step 2: Seller issues their invoice to the buyer, with payment to be made within a certain number of days (e.g., 30, 60, or 90 days)
Step 3: Buyer approves the payment invoice
Step 4: Seller requests early payment on the invoice
Step 5: Funder (Supply chain finance partnered with) sends payment to the supplier, with a small fee deducted
Step 6: Buyer pays the funder on the invoice due date as per their agreement
Where accounting is concerned, the buyer who implements the SCF program will need to make sure SCF is classified as an on-balance sheet item rather than bank debt.
Let us look at hypothetical examples to get a better understanding of SCM financing:
A buyer places a PO (Purchase order) with a seller for products. Typically, the supplier would send the products to the customer and then submit an invoice in accordance with their payment terms (such as net 30). The customer would then have 30 days to settle their invoice.
If the supplier needs their invoice paid sooner (or if the buyer doesn’t have the cash in hand or wants to use it for working capital), they can use an existing supply chain financing platform. This involves the financer or lender, who will immediately pay the purchase invoice on the buyer’s behalf and then extend the payment terms to the buyer agreed upon.
This is a win-win opportunity for both the buyer and the supplier: the buyer gets to keep their working capital for longer without jeopardizing their relationship. In contrast, the supplier gets paid immediately, giving them additional working money to use. There are other benefits as well.
Some of the critical benefits for sellers are:
Optimizing working capital: Suppliers who use supply chain finance might get paid for their invoices sooner than they would otherwise. Consequently, their days’ sales outstanding (DSO) has decreased, resulting in increased working capital.
Access lower-cost capital: Because the cost of funding for suppliers is typically cheaper than it is for other funding sources, such as factoring, supply chain finance is an appealing option to access cash.
Apart from optimized working capital, Some of the critical benefits for a buyer are:
Improve supply chain health: By providing supply chain financing to suppliers, buyers can lessen the risk of a future disruption in the supply chain affecting their own operations.
Strengthen supplier ties: By offering low-cost capital to suppliers, buyers may enhance their relationships with them and, as a result, maybe in a better negotiation position.