Supply Chain Finance is a term that gets a lot of usage in many different situations and leads to a lot of confusion as the term covers two distinct methodologies:
One that provides finance for your purchases or manufacturing costs, and that then flows into the finance of your sales invoices,
and a second that provides finance to your suppliers, i.e. your supply chain, made possible as a result of your purchase order and the strength of your business.
Two definitions:
1. The first definition of Supply Chain Finance as described above has traditionally meant that a business secures funding for each step of their business process, from order through to sale.
This process would start with a trade finance facility where you would normally be funding an order from a customer which, when delivered, is in a finished state. This can be either domestic or international. This is sometimes called a purchase order facility.
If a company is a manufacturer, it is also possible to finance the construction process for a firm order. This would be in the form of stage payments that would be made available at specific stages and would likely be measured by some form of professional valuer before the finance is released.
Once the goods have either been delivered to your warehouse, or you have finished the manufacturing process, delivery can be made to your customer. At this time you will be able to raise the invoice which can then be financed from an invoice finance facility and the trade finance or stage payments repaid.
The invoice finance facility will advance anywhere between 70 and 90% of the total value with the balance being paid to you when the invoice is settled by your customer
2. The second definition of Supply Chain Finance is relevant when the buyer’s suppliers are receiving finance, and has also historically been known as Reverse Factoring.
The Supply Chain in this instance is the input suppliers to your business and the instigator of the services is usually the buyer. The buyer will identify parts (or all) of their suppliers who would benefit from quicker payment terms than their contractual agreement.
They will then find a provider of these types of ‘Supply Chain Finance’, or ‘Reverse Factoring’, and request that they fund their suppliers by providing finance against the invoices the supplier raises to the Buyer. These transactions will be based on the balance sheet of the buyer and not that of the supplier!
The finance provider will fund the individual invoices the supplier has raised to the Buyer on normal invoice discounting terms.
Could either of these methodologies work for your business?
There is no reason at all that any business buying in goods to satisfy orders shouldn’t use traditional Supply Chain Finance. If you are then selling the products on a credit basis, this finance can be extended into an invoice finance facility.
The ideal situation is for the transaction to be based on the purchase of finished goods for confirmed orders. It is much more difficult to fund stock purchases on the basis of previous sales.
With regard to the second type of Supply Chain Finance, this can be an exceptionally good tool to ensure the sustainability of the businesses that make up your Supply Chain by helping them have a healthy cash flow.
If you are a supplier to a large company and you would like to be able to receive payment quicker than the agreed payment terms, you could suggest to your customer that they investigate Supply Chain Finance or, as they may know it, Reverse Factoring. The advantage to them would be a happier and more financially robust group of suppliers who were receiving cash on delivery for a small cost.
If you have any comments on this article or would like to discuss Supply Chain Finance and how it could potentially improve your cash flow please contact me at john.thompson@transcapital.co.uk or on 0845 689 8750.