Reframing How We Look at Supply Chain Finance and Dynamic Discounting

Dynamic discounting or supply chain finance? It’s a common question for many finance and supply chain executives. With so many trade finance options available today, it can be difficult to understand the advantages of each and when they should be used.

Let’s start with what they have in common. Both supply chain finance and dynamic discounting are sustainable and powerful ways for buyers to strengthen their financial statements. The benefits for suppliers are equally as strong. With both solutions, suppliers can accelerate payment and improve cash flow. The difference is in how these benefits are delivered.

Supply chain finance and dynamic discounting defined

Supply chain finance enhances cash flow by allowing buyers to optimize supplier payment terms while providing the option for their suppliers to get paid early. This results in a win-win situation for the buyer and supplier. By paying later, buyers can improve working capital and hold onto cash longer to pay for strategic growth and financial initiatives (e.g. innovation, transformation, debt reduction, etc.). Meanwhile, the supplier generates additional operating cash flow so they too can invest in things like growth and financial health. Supply chain finance is typically funded by a third-party, most commonly a financial institution.

Dynamic discounting takes a different approach. Whereas supply chain finance is focused on generating cash flow improvements, dynamic discounting increases a buyer’s profitability by reducing its cost of goods sold (COGS) and providing an opportunity to earn returns greater than interest income on excess cash. It gives buyers the ability to pay their suppliers early in exchange for a reduced price on the goods or services purchased, the discount. Discounts are usually applied on an invoice-by-invoice basis and may vary based on the date of supplier payment. The earlier the payment is made, the greater the discount. Unlike supply chain finance, programs are typically funded by the buyer’s excess cash.

It’s important to point out that both solutions are effective options with tangible benefits to both suppliers and buyers. They add another layer of financial security, which is particularly important as companies rebound from recent economic and supply chain disruption – particularly in industries like automotive, electronics and raw materials that are facing widespread and sustained disruption. Supply chain finance and dynamic discounting have played a critical role in helping many buyers and suppliers withstand volatility.

When should each solution be used?

While both supply chain finance and dynamic discounting deliver similar macroeconomic benefits, the root problem and circumstances behind the application of each solution tends to differ. Supply chain finance is ideal for companies that want to hold onto cash for longer, improve working capital, increase days payable outstanding (DPO) and leverage third-party funding to offer suppliers early payment. It’s also designed for companies that want to give suppliers access to lower-cost capital than they would be able to secure on their own. This is because supply chain finance rates are based on the buyer’s credit rating instead of the supplier’s.

If you are looking to put extra cash to work and yield a higher return on liquidity than if those funds were being held in an interest-bearing account, dynamic discounting is the preferable option. Early payment discounts translate into lower COGS and higher margins. It’s also a great solution if you have suppliers that are unwilling to extend payment terms or are ineligible for third-party funded supply chain finance. With dynamic discounting, you can still offer the benefits of early payment (and the upstream benefits of a more financially-viable supply chain) to your suppliers. It’s also a great alternative to static early payment discounting programs. These often lack the flexibility buyers and supplier require.

Should you consider one or the other, or both?

Contrary to popular belief,  the use of supply chain finance and dynamic discounting to strengthen the financial supply chain doesn’t have to be an either/or decision. In fact, the two programs can run simultaneously to help buyers and suppliers fully leverage the power of trade finance.

Consider this scenario. An automotive manufacturer needs to make substantial and immediate improvements to cash flow to head off the financial stresses of the global computer chip shortage. Extending supplier payment terms is the most effective course of action, but the manufacturer doesn’t want its suppliers to suffer as they’re also feeling the impact of the chip shortage. The manufacturer launches a supply chain finance program which enables them to improve cash flow while giving suppliers a way to get paid early. This will help all parties become more financially stable, resilient and capable of withstanding what’s predicted to be a two-year slowdown in the computer chip supply chain.

Approximately 60% of the manufacturer’s suppliers qualify to participate in the third-party funded supply chain finance program. The other 40% – comprised mostly of smaller suppliers that are more financially vulnerable – are also given the option to get paid early so they can be more financially resilient. These suppliers will participate in a dynamic discounting program that’s funded by the manufacturer’s cash reserves.

The key to executing this scenario is removing the complexity of running two parallel programs. Like any trade finance program, complexity erodes results and ROI. It’s important to work with a single solution provider that allows buyers to seamlessly manage both programs and KPIs through a single platform as well as provide a single platform for supplier onboarding and participation. When implemented with the right provider, supply chain finance and dynamic discounting can capture the full potential of early payment’s impact on buyer and supplier balance sheets.

This article was originally published on Supply & Demand Chain Executive.