What is Supply Chain Finance – Its Process, Working and Fees
Efficient supply chain management facilitates achieving several business objectives simultaneously. As an essential component of the supply chain, supply chain finance deals with financial management of business-to-business or business-to-customer brands.
Read on to know the meaning of supply chain finance and how it benefits buyers and suppliers.
What is Supply Chain Finance?
Supply chain finance means advancing cash from sellers to buyers via financing institutions like banks. That way, buyers can finance their invoices through a financier, also known as a factor. Factors essentially lessen the burden of financing costs and improve efficiency for buyers and sellers.
Supply chain finance consists of technology-based platforms that ease transactions, especially for buyers with better credit ratings. Thus, buyers can access capital to ward off their invoice burden, while sellers can lessen the gap of receiving payments from an intermediary financial body.
How Does Supply Chain Financing Work?
An event or trigger in the physical supply chain drives financial intervention. Intervention may include payments, financing or risk mitigation for supplier’s invoices.
Imagine sending a purchase request for a mobile phone via the seller’s website. The supplier checks their inventory and takes more orders from the manufacturer. Instead of cash, you choose internet banking to pay. The financial body immediately tracks your order while the supplier prompts them to accept payment on their behalf.
While making the payment, you can opt for other payment methods like UPI or the seller’s financial partner. The supplier and financial institution agree to discount the invoice at a mutually agreed rate even if they are present as separate identities.
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Supply Chain Finance Process Explained
The process of supply chain financing functions in different ways depending on the supplier’s operational structure. Supply chain finance companies can discount receivables, purchase future payment obligations, or even factor up to 90% of the invoice value.
Steps involved in a supply chain finance process include:
Step 1: Orders for goods and services are placed by the buyer from the supplier.
Step 2: The buyer receives an invoice for the purchase with its payment due within a certain time period (1 month, 3 months, 6 months, etc.)
Step 3: The supplier receives approval for the invoice payment from the buyer.
Step 4: The supplier requests payment on the invoice from the financier or financial institution in question.
Step 5: The financial institution (banks, for example) deducts a small fee and pays the balance amount to the supplier.
Step 6: The buyer pays off the financial institution on the invoice due date.
Depending on the type of payments buyers have opted for, the supplier can create unique payment options. Thus, buyers can make purchases with payment options stretching to up to 5 years.
Supply Chain Finance Example
As an important component of supply chain management, SCF assists both buyers and suppliers. Imagine a buyer placing orders for a pair of shoes from a supplier.
With the order placed, the supplier ships the product to the buyer and submits an invoice for its payment. They can leave the buyer to make the payment under a fixed term (say 30 days).
However, the buyer may opt for a longer payment term (say 60 days or more), or the seller may want its invoice to be cleared faster.
With financial supply chain management, a third-party financier may agree to pay for the invoice immediately. The financial intermediary pays for the invoice on behalf of the buyer and gives them a payment term.
This example shows that buyers and sellers can benefit from supply chain finance. With immediate payments, the supplier can use this as its working capital. The buyer can take their time to pay for the product without spoiling their relationship with the supplier.
Costs and Fees in Supply Chain Finance
While opting for a supply chain financing solution, the involved parties must bear certain costs and fees. Consider an example where a retail company buys a certain product from a supplier on certain terms.
- Company XYZ buys 10,000 pairs of shoes from their supplier ABC at Rs. 200 a pair. Their total payable amount stands at Rs. 20,00,000.
- The invoice lists the product details, their quantity, payment terms (say 60 days) and other delivery terms.
Instead of waiting for 60 days to settle the invoice, ABC opts for a supply chain finance company. Together they agree on the following paying terms:
- Financing term: 60 days
- Total invoice amount: Rs. 20,00,000
- Financing amount: 80% of the invoice = Rs. 16,00,000
- Servicing fees: 5.5% of the invoice amount = Rs. 88,000
- Maturity repayment amount: 20% of the invoice – servicing fees = Rs. 4,00,000 – Rs. 88,000 = Rs. 3,12,000.
The supply chain finance company will pay the financing amount of Rs. 16,00,000 to ABC. Company XYZ pays the financing company the full invoice amount of Rs. 20,00,000 after 60 days. The latter then pays the remaining 20% of the invoice minus servicing fees to ABC who receives Rs. 3,12,000 to end the deal.
Benefits for Sellers Using Supply Chain Financing
Financial supply chain management aid sellers or suppliers in optimising their working capital. It also helps them manage their finances well. Following are certain benefits sellers can obtain through SCF:
- Working capital optimisation: Suppliers can receive payment for their invoices faster through supply chain financing. Due to a reduction in the outstanding days for sales, suppliers can circulate their working capital better.
- Lower cost funding: Unlike other financing methods, SCF offers much cheaper financing. Other sources of funding, like factoring, are comparatively more expensive and slower.
- Better cash forecasting: Supply chain financing provides a better insight into incoming payments. This helps companies manage their future cash flows.
Benefits for Buyers Using Supply Chain Financing
Like sellers, buyers can also make use of supply chain finance to improve their shopping experience. Following are some advantages of supply chain financing for buyers:
- Strengthening relationships with the supplier: With supply chain financing, buyers can maintain stronger relationships with suppliers. With low-cost funding and the opportunity to pay later, buyers stay in a stronger negotiating position.
- Improving supply chain relationships: Through SCF, buyers can reduce the possibility of supply chain disruptions.
- Liberty to purchase: Buyers have the full liberty to make purchases from any supplier with SCF. Most suppliers offer financing for almost all household products with flexible payment terms.
What is Flexible Funding under Supply Chain Finance?
Often, companies club supply chain financing and dynamic discounting together. For example, leading e-commerce websites can offer dynamic discounting for their buyers while still offering options for SCF.
Although buyers can opt for these two solutions simultaneously, sellers can choose two different vendors to fulfil the financing.
Flexible funding solutions include third-party and self-funded payment models within a single user interface. Thus, Company XYZ can utilise a single early-payment platform to help buyers access both types of financing. Depending on their working capital and purchase requests, buyers can switch between these two.
How to Apply for Supply Chain Finance?
A typical supply chain finance model allows buyers and sellers to mutually agree with a finance provider. Supply chain finance programs are often funded by multiple banking institutions running on a user-friendly online interface.
To apply for SCF, buyers and sellers must agree to the terms and conditions set by the financing company. E-commerce giants like Amazon allow buyers and sellers to choose their banking partners and set specific conditions for financing.
Depending on the payment terms, they allow buyers to clear their payments at their ease. Sellers can also avail a financial intermediary to pay off their invoices immediately.
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Things to Know Before Applying for Supply Chain Finance
There are various techniques and options available to buyers and sellers in terms of SCF. Here are the four types of supply chain finance that one can consider before applying for SCF.
- Discounting receivables: Suppliers can discount their payments receivables either fully or partially to a financial entity. This helps them receive a cash injection to keep their business process running.
- Purchasing future payment obligations: Suppliers and sellers can enter into mutual agreements with financial bodies to purchase their future payment obligations. Banks, for example, can extend loans against invoices guaranteed by the buyer’s banking partner.
- Loan against receivables: Sellers can receive loans or advances from finance companies for current or future trade obligations. These loans can be received on expectations of future payments and can help improve supplier terms. They also help suppliers raise capital for their normal activities.
- Loan against inventory: Buyers and sellers can receive loans or advances for warehousing and strengthening their inventory. Inventories must be identified and segregated to determine a specific value. Marketable commodities like minerals and agricultural products can be put into inventories. Sellers can take supply chain financing help from intermediaries to replenish their inventories.
Final Word
Supply chain finance addresses 5 basic areas of supply chain management: production planning, supply planning, inventory management, capacity planning and distribution.
Financial intermediaries like banking institutions aim to bridge the gap between these areas and fund them. The tech-based services in supply chain finance ensure efficient management of finances for both buyers and suppliers.
FAQs
Ans. Supply chain finance involves bringing buyers and sellers together via a financial intermediary. During a purchase, buyers can set payment terms on a mutually agreed date and amount with the sellers. Sellers can obtain financing to this invoice amount via a financier who pays about 80% of the expense in addition to a fee.
Ans. Financial intermediaries can advance cash to sellers within hours of a purchase initiated by a buyer. They also allow easy sign-up and verification with multi-currency capabilities. Plus, their fees are transparent and straightforward, allowing sellers to easily finance invoices.
Ans. Unlike SCF, small buyers receiving goods from sellers can fund their transactions with a trade financing institution. Creditworthy suppliers can use letters of credit and cash upfront from large lenders to finance their payments.
Ans. Some of the most common types of supply chain financing include financing purchase orders, invoice discounting, loans and factoring. These services are most offered to medium and large sized companies.
Ans. In traditional factoring, the supplier requests a financing institution to finance their receivables. On the other hand, in SCF, the customer or the ordering party initiates the financing process.
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