Supply chain finance, also known as reverse factoring, links the seller, the buyer and the financing party to improve business cash flow on all sides.
How Supply Chain Financing Works
In leveraging supply chain finance, suppliers sell outstanding receivables to financial institutions to accelerate payment of receivables and extend payment flexibility to customers.
Once the supplier sends an invoice to the buyer, the buyer confirms to the financial institution that the invoice is approved and the supplier receives payment immediately. When the invoice is due, the buyer pays the financial institution back.
Benefits for Buyers Using Supply Chain Financing
There are many benefits for buyers using supply chain financing, including increased liquidity, less contentious relationships with suppliers, decreased liabilities and consolidated finances.
Increased Liquidity
Buyers initiate reverse factoring so their suppliers receive more streamlined payments at lower interest rates. The process aids liquidity for buyers because they receive lengthier and generous payment terms.
Suppliers that work with a factor always know when to expect payment. (Usually, they receive payment more quickly, which helps ensure a healthier cash flow.)
Buyers also don't need to contend with early payment requests from suppliers. In the reverse factoring process, suppliers are already paid at previously agreed-upon, and typically faster, terms.
Less Contentious Relationships
Supply chain finance helps the supply chain process run more smoothly and provides advantages for everyone involved.
In dealing directly with a supply chain funder (i.e. the factor), buyers can usually avoid payment disagreements with suppliers. When buyer/seller relationships don't deteriorate based on late payments or failure to pay, they can grow stronger and build trust, and are thus more likely to expand.
Decreased Liabilities
A business liability is money owed from past transactions that will require additional funds to resolve.
Buyers want to reduce liabilities so they can procure lower interest rates from lenders and maintain overall financial health. Using reverse factoring, the factor is on top of invoices and payments so buyers can focus on other things.
Consolidated Finances
It's always easier to pay one company instead of a dozen.
Using reverse factoring, buyers can centralize all supplier payments under the same financier, which may use a digital platform that makes invoice tracking even simpler for the buyer's accounting team.
Benefits for Sellers Using Supply Chain Financing
Supply chain financing isn’t just beneficial for buyers. Sellers also benefit from supply chain finance in the form of more reliable payments, lower interest rates, less time spent on accounting and more credit options.
More Reliable Payments
As mentioned above, suppliers that work with a factor always know when to expect payment. (Usually, they receive payment more quickly, which helps ensure a healthier cash flow.)
Factors typically eliminate concerns about non-payment and delayed or fraudulent payment.
Lower Interest Rates
In a reverse factoring agreement, the interest rate offered by the financier is lower than in other arrangements. This is because it's determined by the buyer's credit rather than the supplier's rating.
Less Accounting Time
Suppliers may spend hours per week following up on invoices and negotiating payment terms with buyers. When organizations engage in supply chain finance and factoring companies take over many of the administrative headaches, business owners can spend less time on accounting and more time strategizing for growth.
More Credit Options
Let's say that you are a manufacturer that needs to increase inventory. Your organization might work with a supply finance company that provides credit to purchase materials and serves as a liaison between your company and your supplier.
Upon placing an order to the supply financier, the order goes to your supplier who will then deliver the goods to you. The financier pays the supplier directly and invoices you as the business owner.
How to Set Up Your Business for Supply Chain Finance
Is supply chain finance for you? You can make an informed decision by considering your or your buyer's size, investigating new technologies, researching and selecting the right vendor, and onboarding participants.
Consider Size
Supply chain finance is better for larger and possibly global buyers, since these organizations tend to have stronger credit. The stronger the credit, the more likely you are to secure a helpful factoring agreement.
Investigate New Technologies
Looking to the future, several technology advances are making the supply chain finance proposition even more compelling. For example, blockchain helps with transaction transparency and authentication, while artificial intelligence is helpful for more accurate credit scoring.
Research Vendors
If you're a buyer, you are responsible for selecting a supply chain finance vendor. You should look for financial institutions with experience in your industry that have worked with similar supply chains. The chosen vendor should offer a robust software platform for invoice management.
If you're a supplier, you might discuss the potential for supply chain finance with your larger customers, since they must initiate the process.
Onboard Participants
Once they're set up with a supply chain financier, buyers must invite suppliers to join the program, and suppliers who accept must complete an onboarding program that ensures all parties will work together seamlessly. Try to make the process as non-complicated as possible.
Supply chain finance is an excellent strategy to improve working capital and cash flow for buyers and sellers alike. Consider the advantages and take steps to put it to work for your business today.
Read more articles on financing.
A version of this article was originally published on November 25, 2019.
Photo: Getty Images
