The basic principles underpinning supply chain finance (SCF) aren’t by any means new. In fact, supply chain finance dates back nearly 50 years. To help their suppliers weather an economic downturn in the 1970s and ’80s, Italian automaker Fiat began using the practice to help maintain its supply chain during the recession.
While an established practice, SCF is often misunderstood, both functionally and reputationally. Generally speaking, supply chain finance, sometimes referred to as reverse factoring, covers the financing needs of suppliers providing goods and services to large buyers where suppliers can access third-party financing for invoices.
It is worth noting that dynamic discounting is a related solution often lumped together with supply chain finance. In dynamic discounting, the buyer funds the program, enabling suppliers to access early payments on invoices in exchange for a discount – without third-party capital.
SCF fulfills the basic need of financing the working capital necessary to run any business. When successfully delivered, SCF benefits the entire buyer/seller dynamic and it improves certainty for suppliers by providing payments for delivered goods and services earlier than agreed terms with the buyer. SCF enables stable, on-demand, reduced-risk transactions that facilitate better relationships between suppliers and buyers.
How Supply Chain Financing Works
In its simplest form, supply chain finance takes place in five stages:
- Buyer purchases goods or services from the seller.
- The seller delivers purchased goods or services and invoices the buyer.
- The buyer approves the invoice and notifies the SCF provider
- The seller can choose to opt in for early payment (paid by SCF provider, for a fee) or wait for the invoice to mature and get paid by the buyer at no fee.
- The buyer settles the account with payment to the SCF provider in accordance with the agreed terms.
While the general process is universal, providers can vary. Traditionally, supply chain finance programs were the exclusive purview of banks. Banks have the balance sheets to give them the wherewithal to support buyers and suppliers financially, however, they are often hampered by technology limitations that make the process difficult. In response, SaaS vendors and their platforms have emerged as major players in the supply chain finance industry. Unfortunately for buyers and suppliers, SaaS offerings often lack substantial financial resources in their balance sheet and rely solely on third-party funding to scale to adequately meet working capital needs.
The best solutions combine access to diverse funding sources (including banks and other financial institutions, as well as the SaaS company’s own balance sheet with a modern, cloud-based platform. When a single supply chain finance provider has both, as LSQ does, buyers and suppliers can access a reliable source of capital faster, safer and with more transparent decision-making tools for risk mitigation and credit analysis.
Benefits of Supply Chain Financing
Buyers are increasingly seeking to improve their cash conversion cycle by extending payment terms to suppliers. Suppliers need greater predictability in their cash flow but lack access to adequate sources of capital. This conflict has the potential to reduce liquidity and resiliency across supply chains. A successful supply chain finance program balances these conflicting needs of buyers and suppliers.
Benefits to Buyers
Improved Relationships with Suppliers – Participating in a supply chain finance program helps suppliers bolster their working capital, creating a situation that encourages the continuation of a successful partnership.
Optimized Working Capital – Supply chain finance programs free up cash and lower cost of capital (when compared to traditional financing) by extending payment terms.
Diversified Supplier Pool – By providing options for fast, flexible access to cash, more suppliers are incentivized to do business with you.
Stronger Supply Chains – By supporting your suppliers with more predictable cash flow, their businesses are in a better position to be a partner in your business growth.
Benefits to Suppliers
Improved Liquidity – Supply chain finance programs provide suppliers with payments in as little as 24 hours, instead of waiting 30/60/90-plus days dictated in the original terms with buyers.
Payment Certainty – Suppliers can choose when and which of their approved invoices get paid when participating in a supply chain finance program.
Predictability – With supply chain financing, suppliers can prevent gaps in production, allowing for flexible forecasting and growth.
Reduced Financing Costs – Accessing working capital through a supply chain finance solution is often a more affordable option than other types of financing.
Liquidity and certainty are often hard to come by in today’s challenging economic environment, which is unfortunate since the overall health of your business is dependent upon having reliable access to working capital. A well thought out and managed supply chain finance strategy can help suppliers bridge the gap between their cash needs and extended payment terms and can help buyers hold on to their cash longer to make the best use of their financial resources.
To learn more about LSQ’s working capital solutions, visit lsq.com/platform/supply-chain-finance/.
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