The Potential of Supply Chain Finance

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What would be the effect on your company’s relationship with its suppliers if it was able to pay them immediately after receiving goods and services? What if payment terms were open for discussion and could be improved for buyers and suppliers alike? What would be the effect on your company’s financial performance if on the […]

What would be the effect on your company’s relationship with its suppliers if it was able to pay them immediately after receiving goods and services? What if payment terms were open for discussion and could be improved for buyers and suppliers alike? What would be the effect on your company’s financial performance if on the one hand it could achieve favorable payment terms from its suppliers while on the other hand it was paid immediately by its own customers? The short answer is that ultimately the cost of goods for buyers would be greatly reduced while access to financing and risk exposure for suppliers would be greatly improved. This of course would reduce the inherent friction between buyers and suppliers and could lead to a level of supplier collaboration previously unheard of.

For many companies, the situation described above seems clearly impossible to reach. A company’s suppliers will always prefer to have the shortest payment terms possible while the company itself will always prefer to have the longest payment terms possible. Moreover, as that same company is also a part of a larger supply chain it too will want to negotiate the shortest payment terms with its own customers. Nevertheless, many companies today are in fact able to overcome this dilemma of divergent priorities (and achieve the benefits described above) through the use of supply chain finance.

What is supply chain finance?

Traditionally, suppliers have been responsible for facilitating commerce by providing financing (usually in the form of favourable payment terms) to buyers. But in the difficult economic environment that companies find themselves in today, this solution is no longer sustainable. With every organization in the supply chain actively trying to protect their bottom line, all parties must show value for their money and make the best use of their limited resources. In response, a new market for supply chain finance solutions has emerged.

How it Works

Within this market, there are numerous approaches that have been developed. Each caters to a different situation depending on the ambitions and risk tolerance of the buyers and suppliers and the financial infrastructure available. Here, we will highlight three of the most common solutions.

1 – 3rd Party Supply Chain Finance Vendors

 Several 3rd party vendors have developed supply chain financing solutions in order to address the dilemma of divergent priorities between buyers and suppliers. These solutions, which are usually web-based, allow a buyer to post approved invoices to a system (presumably after the buyer has completed a three way match: purchase order, invoice and receipt). The supplier is then able to see that the invoice has been approved (in and of itself a benefit to suppliers) and decide whether or not it wishes to sell its receivables to a third party financial institution or whether it wishes to wait to be paid by the buyer. This added flexibility is the real benefit to suppliers as it allows them to have better control of their own financing. Having collaborated in this way to improve the visibility and financial position of the supplier, the buyer can then try to negotiate more favourable payment terms for itself.

 2 – Supplier Transaction Fee Deduction

 In its simplest form this option is similar to how a credit card system works; a monthly fee is paid and a percentage of the transaction amount is deducted from the final invoice settlement. Within a company’s procurement system, the transaction is suitable for either the eInvoicing or P-Card settlement.

For this type of solution, a company would need to have automatic invoice matching in place to allow for the cost of the settlement process to be reduced and for quicker payment of suppliers to be realized. The latter, of course, can be used during the negotiation process with suppliers to drive better discounts.

3 – Invoice Intervention

 Supply chain financing works by allowing an intervention in the transaction between buyers and suppliers, which allows for a discount to be negotiated by settling invoices earlier than the contracted payment terms. The invoice is then settled within the contracted terms by the buying organization settling the credit balance created by the early settlement by the service.

Each supply chain is different, so no single solution is likely to work for all companies. An analysis of the requirements of the situation is necessary – looking at procurement patterns, supply base structure and the specific needs of the buyers and suppliers.

Why your company might be interested in supply chain finance?

As alluded to in the introduction to this post, there are many potential benefits to supply chain finance solutions. Below is a select list of just some of the most obvious benefits for buyers and suppliers.

 Benefits to Buyers    

Buyers benefit from increased flexibility in cash flow (without changing contract terms), the potential for improved payment terms, and reduced supplier risk.

 Benefits to Suppliers

Suppliers benefit from better visibility into invoicing settlement, improved cash flow and payment certainty and increased flexibility for their business.

The dilemma of the divergent priorities between buyers and suppliers is well known. Unfortunately, the potential of supply chain finance is much less well known. With the current economic outlook still quite bleak, it is undoubtedly only a matter of time before companies start to better understand the topic of supply chain finance and begin to implement some of the many solutions available today.

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