Supply chain finance, or as it known as supplier finance or reverse factoring, is a set of solutions that improve cash flow by allowing companies to extend payment terms to their suppliers while providing an option for their large suppliers and SME Suppliers to get paid early.
With global supply chains stretching across the globe with multinational buyers on one side and a variety of suppliers in many countries on the other hand, companies are under pressure to open up the working capital trapped in their supply chains.
This results in a win-win situation for both the buyer and the supplier. The buyer optimizes working capital, and the supplier creates additional operating cash flow, thereby reducing risk throughout the supply chain.
SCF or Supply Chain Finance is a large and growing industry. In 2015, a McKinsey report indicated that the SCF fund has a global revenue potential of $20 billion, while a 2017 ICC survey of banks in 98 different countries identified SCF as the most important area for development and strategic focus in the next 12 months.
Obviously, SCF is an important topic that anyone involved in trading and trade finance to be familiar with.
WHAT IS SUPPLY CHAIN FINANCE?
The business activities of any company can be divided into two categories: physical supply chain and financial supply chain:
As you see, the physical supply chain is the flow of goods and services towards the end customer. Whereas, the financial supply chain is the flow of funds from the customer back up the chain to the supplier.
Supply Chain Finance (SCF) refers to the methods and practices used by banks and other financial institutions to manage the capital invested in the supply chain and reduce risk for the parties involved.
Every financial intervention like (financing, risk mitigation, or payment) in the supply chain is driven by an event or “trigger” in the physical supply chain. And here are some examples of these events:
- Purchase orders.
- Pre-shipment inspections.
- Dispatch/shipment
- Invoices raised by the seller.
- Goods accepted by the buyer/ entered into the warehouse of the buyer.
WHY HAS SCF GROWN IN POPULARITY?
International trade has long been financed through a series of instruments referred to as “traditional” trade finance (eg documentary credits).
However, over the past few years there has been a decided and sustained global shift away from these familiar mechanisms, based on the preferences of importers and exporters to conduct trade on “open account” terms, where goods are shipped and delivered before payment. Worthy. In 2016, the total volume of SWIFT trade finance showed a decrease of 4.72%.
This shift stems, in part, from emerging markets that believe that the insistence on documentary credit-based trade reflects a lack of trust in those markets and their institutions. Change has also been brought about by moving away from traditional bilateral trade arrangements (one buyer, one seller) to truly global supply chains that may now include relationships with communities of up to 10,000 suppliers.
In this open account trade ecosystem and a large, complex network of suppliers, the use of SCF has blossomed.
OPEN ACCOUNT TRADE
Supply chain finance is usually applied to open account trade where the goods are shipped and delivered before payment is due. The goods, with all necessary documents, are shipped together directly to the importer who has agreed to pay the invoice on a specified date.
Obviously, this option is the most advantageous to the buyer (Importer) in terms of cash flow and cost. The seller or (Exporter) accepts potential cost, significant risk, and the possibility of non-payment for a variety of reasons – some of which may not even be under the exporter’s control.
So why do exporters choose to use open account trade?
Because open account trade can help bring customers into competitive markets and exporters can use one or more appropriate trade finance methods to mitigate the risk of potential non-payment.
HOW IS SCF DIFFERENT TO TRADE FINANCE?
A common question about supply chain finance is how it differs from traditional trade finance.
While both trade finance and supply chain finance are designed to finance international and domestic supply chains, trade finance offers a broader range of solutions.
Traditional trade finance
Trade finance products have been around for a long time and include letters of credit, bank guarantees and documentary collections, all of which are frequently used when trading partners do not know each other well or don’t know it at all.
Supply chain finance
Supply chain finance refers to financing and risk mitigation techniques that have been developed recently and are likely to be used in connection with open account trade where buyer and seller have done business together before.
BENEFITS OF SCF TO EACH PARTY INVOLVED
Seller (Exporter)
- The exporter could be (and is often) a small to medium-sized enterprise, often based in a developing or emerging market, supplying to a large buyer, perhaps based in the Americas or Europe. In such a scenario, SCF provides a small supplier a range of options for accessing affordable financing, possibly reducing the time it takes to collect payments and thus dramatically improving the company’s cash flow which can be used for something else.
- Removes outstanding debts (receivables) owed by the company from its balance sheets.
- Allows another party to assume the payment risk on their behalf.
Buyer (Importer)
SCF allows the buyer to often use a higher credit rating for obtaining better payment terms.
SCF enables the importer to ensure the financial health of his suppliers and service providers who sustain a particular supply chain which helps to ensure ongoing operations, timely production and continuous sales activity.
SCF enables importers to make banks and finance providers to assume risks on their behalf.
Banks
SCF means that banks and other financing providers can buy the assets at a discount which they can then sell to investors and make a profit when the full amount of receivables is collected.
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