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Supply Chain Trade Finance Gains Traction

By Justin Grensing

Supply chain financing has been hailed as a potentially revolutionary way for companies to shore up their working capital.1 But while there is a high level of interest among suppliers, buyers, and financers, many observers see a major gap in trade finance—to the tune of $1.5 trillion as of 2016.2,3 While a significant gap remains between the need for and the availability of supply chain finance, continuously improving technology and the potential emergence of a network effect might be ushering in a new wave of interest and adoption.

Factoring Market Can Aid Trade Financing

 

Supply chain finance is defined by Investopedia as “a set of technology-based business and financing processes that link the various parties in a transaction—buyer, seller, and financing institution—in order to lower financing costs and improve business efficiency. Supply chain finance provides short-term credit that optimizes working capital for both the buyer and the seller.”4

 

The process works by manipulating payment terms to improve net working capital (NWC), among other things. In general, buyers want to delay payment as long as possible and sellers want to receive payment as soon as possible.In practice, many companies use net 30-day payment terms, which means complete payment is due 30 days from the date of the purchase. With only buyer and seller involved, a delay in payment by the buyer necessarily means a delay in receipt of payment by the seller.

 

Factoring—a common form of supply chain finance—adds a third party to the transaction in the form of a financer, such as a bank, also called a "factor." Through factoring, the seller can assign its receivables to a factor at a discount and get paid immediately. The terms of the agreement with the factor could even include a longer payment period for the seller.

 

Improving NWC with Supply Chain Finance

 

Using supply chain finance, such as factoring, can improve a company’s NWC. Traditional financing will typically incur a debt, which can be detrimental to a business balance sheet. By contrast, when structured properly, supply chain finance will keep payments owed to suppliers as accounts payable, as opposed to debt.6

 

While potential investors like to see a strong NWC and low debt-to-income in the financials of publicly traded companies, there’s more that can result from these measures than just boosting the stock price. Just as with an individual's finances, having more liabilities than assets mean a company could be unable to pay its creditors or even be forced into bankruptcy. By contrast, a company with high NWC has opportunities to invest in growth.7

 

Meeting the Unmet Supply Chain Finance Need

 

While the lack of supply chain finance can hurt a company’s financials, it can also eliminate potential trade opportunities, harming the broader economy.8 And the lack of available financing tends to hurt small and medium enterprises (SME) far more frequently than large companies.9 Making matters worse, big companies will sometimes use their superior leverage to force longer payment terms on their suppliers, while demanding shorter payment terms from their customers, squeezing SMEs on both ends.10

 

There are ways to alleviate some of these issues, according to experts. BNY Mellon’s 2019 global survey, Overcoming the Finance Gap: Root Causes and Remedies, found reduced regulation to be a top recommendation for increasing the availability of supply chain finance among its respondents.11 Finance is a highly regulated and complex process in general, and, with global supply chains, financing those transactions adds the complexity of regulations around cross-border money flows, anti-money laundering, and other considerations.12 Moreover, the multinational nature of the financing and the desire to share risk often means that a single transaction might require multiple financial service companies.13

 

Digital Finance Comes to Supply Finance

 

The other top response from BNY Mellon’s survey focused on the importance of improved technology. Respondents to the Asian Development Bank’s 2017 Trade Finance Gaps, Growth, and Jobs Survey similarly believe that financial technology and digitization can be a solution to the lack of trade finance for SMEs, noting, however, that awareness and usage of technology needs to improve.14 Improved technology can help enterprises more effectively navigate complex regulations, as well as facilitate multiple financial institutions collaborating on a single deal through shared platforms.15

 

As more companies venture into the supply chain finance arena, there is the potential for a network effect, the phenomenon whereby increased numbers of participants improve the value of goods or services.16 As more buyers, sellers, and lenders are willing to engage in supply chain finance, there are increasing opportunities for matching supply of funds with demands and developing a broader range of creative financing solutions.17

 

The

Takeaway:

Supply chain finance has the potential to boost international trade opportunities and the overall financial health of SMEs. However, adoption of supply chain finance strategies is lacking relative to their potential. Improvements in technology and the rise of a less-complex regulatory framework could help spur adoption beyond the network effect tipping point, which could bring supply chain finance into the mainstream.

Justin Grensing - The Author

The Author

Justin Grensing

Justin Grensing is a freelance writer, MBA and attorney who covers topics ranging from finance, marketing, human resources, legal/compliance, and general business.

Sources

1. “Supply chain finance: silver bullet for working capital,” Euromoney; https://www.euromoney.com/article/b12kn0kr8jnwk0/supply-chain-finance-silver-bullet-for-working-capital
2. “2019 Global Survey – Overcoming the Trade Finance Gap: Root Causes and Remedies,” BNY Mellon; https://www.bnymellon.com/_global-assets/pdf/our-thinking/2019-global-survey.pdf
3. “$1.5 Trillion Trade Finance Gap Persists Despite Fintech Breakthroughs,” Asian Development Break; https://www.adb.org/news/15-trillion-trade-finance-gap-persists-despite-fintech-breakthroughs
4. “Supply Chain Finance,” Investopedia; https://www.investopedia.com/terms/s/supply-chain-finance.asp
5. “Big Companies Pay Later, Squeezing Their Suppliers,” The New York Times; https://www.nytimes.com/2015/04/07/business/big-companies-pay-later-squeezing-their-suppliers.html
6. “Keeping SCF trade payables from being moved into debt,” SCF Briefing; https://www.scfbriefing.com/keeping-scf-trade-payables-from-being-moved-into-debt/
7. “Working Capital,” Investopedia; https://www.investopedia.com/terms/w/workingcapital.asp
8. “$1.5 Trillion Trade Finance Gap Persists Despite Fintech Breakthroughs,” Asian Development Break; https://www.adb.org/news/15-trillion-trade-finance-gap-persists-despite-fintech-breakthroughs
9. “$1.5 Trillion Trade Finance Gap Persists Despite Fintech Breakthroughs,” Asian Development Break; https://www.adb.org/news/15-trillion-trade-finance-gap-persists-despite-fintech-breakthroughs
10. “Big Companies Pay Later, Squeezing Their Suppliers,” The New York Times; https://www.nytimes.com/2015/04/07/business/big-companies-pay-later-squeezing-their-suppliers.html
11. “2019 Global Survey – Overcoming the Trade Finance Gap: Root Causes and Remedies,” BNY Mellon; https://www.bnymellon.com/_global-assets/pdf/our-thinking/2019-global-survey.pdf
12. Ibid.
13. “Payables Finance: A guide to working capital optimization,” Deutsche Bank Corporate & Investment Bank; https://www.cib.db.com/insights-and-initiatives/white-papers/payables_finance_a_guide_to_working_capital_optimisation.htm
14. “$1.5 Trillion Trade Finance Gap Persists Despite Fintech Breakthroughs,” Asian Development Break; https://www.adb.org/news/15-trillion-trade-finance-gap-persists-despite-fintech-breakthroughs
15. “2019 Global Survey – Overcoming the Trade Finance Gap: Root Causes and Remedies,” BNY Mellon; https://www.bnymellon.com/_global-assets/pdf/our-thinking/2019-global-survey.pdf
16. “Network Effect,” Investopedia; https://www.investopedia.com/terms/n/network-effect.asp
17. “7 Supply Chain Financing Trends to Watch in 2019,” Supply Chain Management Review; https://www.scmr.com/article/7_supply_chain_financing_trends_to_watch_in_2019

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