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Setting the Record Straight on Supply Chain Finance

Setting the Record Straight on Supply Chain Finance

By • Published September 15, 2020 • 6 minute read

Since the beginning of trade, the basic negotiation points of any purchase have been the same – what is the price, who owns the goods, when and how does ownership transfer, and how and when will payment take place. Thousands of years later, the purchaser still wants the lowest price, the seller to maintain ownership and risk for the longest possible time, and to pay as late as possible in the manner that is easiest for them – all while guaranteeing a reliable flow of quality goods.

Supply chain finance tackles the last of these negotiating points – when and how payment is made. Let’s say you are a small or medium sized supplier of goods. You’ve negotiated price and title transfer terms that work for your business, and you’ve managed to get your customer to agree to pay you on Day 60. Depending on your industry, these terms may be reasonably standard, or the result of fantastic negotiating by you, or maybe just an act of God (food and beverage – I’m looking at you).

In any event, you still have obligations to meet prior to customer payment – things like buying inventory, paying rent, paying employees, etc. The question is: how can you convert your accounts receivable (what’s owed to you for what you’ve already delivered) to cash to meet your obligations?

Most small or medium sized businesses have a few options:

  • Equity – This is probably the least efficient and most costly option. No explanation required.
  • Bank Loan or Line of Credit – If the bank is willing to lend to you, the loan will likely need to be secured by the assets of your business. If you trend more towards the “small” side, it may even need to be secured by your personal assets.
  • Factoring – This will carry a high rate of interest, will likely carry strict rules and limits, and will advance only 70 to 80% of the value of the A/R. It’s also likely that late payment or dilution could force you to repurchase some of the invoices.
  • P-Card – It’s possible that your customer will be running a p-card program that you can participate in that allow you to collect within a couple of days of when your invoice is approved. But you’ll pay for it. Typical rates range from 2 to 3% of the face value of the invoice to accelerate payment from Day 60 to something like Day 10, which translates to roughly 14 to 21% APR. It’s expensive because there are a lot of mouths to feed in a typical p-card transaction, including the purchaser who will receive rebates from the issuer for one-half to one-third of the total transaction cost!
  • Dynamic Discounting – Your customer could also offer a dynamic discounting program, which basically using their excess cash to generate short-term returns on paying their invoices. If you think the cost of p-cards is high, cover your eyes when you understand the discount rates being sought in dynamic discounting.

None of these options are particularly attractive and all come at a high cost to the supplier – not to mention headache.

Supply Chain Finance – A Much-Needed, Better Option for Suppliers

Supply chain finance provides a viable option that allows you to get paid as soon as your invoice is approved on 100% of their invoice value, electronically to the bank account of your choosing – all for a nominal fee, typically a discount of 0.3 to 0.5% of the invoice’s face value. Transactions follow a true sale of A/R structure and all risk of collection or late payment is transferred to the buyer free and clear. Full transaction details (Level 2) are provided to allow for cash application and reconciliation which ensures trade payables classification (not debt). Even better, you can use it or not use it whenever you want.

Sounds great, right? If you’re a small or mid-sized supplier (or large), it is! Supply chain finance is a far more efficient source of financing than any of the alternatives available to most suppliers.

Buyers are always going to be incented to stretch payment – they have strategic initiatives, investors looking for returns and uses for cash as well. But, without supply chain finance, this only pushes the burden and risk further down the supply chain. When properly implemented, supply chain finance is a true win-win situation for buyers and their suppliers. The buyer can generate excess cash to invest and grow (ultimately a benefit to suppliers) while, at the same time, giving their suppliers an extremely efficient process to accelerate their own cash flows.

Separating Bad Apples From the Bunch

Unfortunately, we live in a world where negative news tends to trump the positive. In the last few years, a handful of illegitimate supply chain finance programs have garnered media attention. Generally, these programs shouldn’t be defined as supply chain finance. Rather they’re some sort of complicated financing structure that the sponsor tries to call supply chain finance. Carillion is a good example. Much has been made of the meltdown of the UK outsourcing giant that once employed 43,000 across the globe and how their “supply chain finance” program ultimately hurt suppliers.

Let’s be clear. Carillion was not operating a true supply chain finance program. They were providing some sort of funding scheme for suppliers to borrow against their invoices to Carillion. In the event that Carillion didn’t pay, the suppliers were on the hook to repay those loans and not be able to collect on the invoices. So, when Carillion went under, their suppliers were liable to the banks which wanted to claw back funds. That hurt their suppliers tremendously.

This is NOT supply chain finance. A true supply chain finance program insulates the supplier from buyer default risk. The supplier sells their rights and interest in the receivables to a funder (typically a financial institution) and the funder bears the risk of buyer default. Had Carillion been running a valid program, no suppliers would have been harmed – all of the risk would have transferred to banks, who are well equipped to manage and monitor credit risk. Just because Carillion called it “supply chain finance” doesn’t make it so.

So, let’s set the record straight once and for all. Observers that conflate properly-run supply chain finance programs with the likes of Carillion’s are creating an inaccurate perception of supply chain finance, one filled with fear, uncertainty and doubt. Supply chain finance is tremendously beneficial to all participants – particularly suppliers and especially small and mid-sized suppliers whose funding options are limited.