For companies looking to improve cash flow, there is no shortage of options. The real challenge is finding an approach that doesn’t have a negative impact on the company’s financials. Conventional methods like raising debt or traditional factoring – both of which increase debt-to-capital ratios –come at a price, as do most working capital optimization strategies.

This is where supply chain finance really sets itself apart as an approach to cash flow improvement. Unlike borrowing or factoring, supply chain finance transactions occur off-balance sheet. This makes them less susceptible to leverage ratio compliance concerns, and actually result in an improvement to these ratios.

So, how do supply chain finance transactions avoid being classified as bank debt? It comes down to the structure of the program. A supply chain finance program must demonstrate that its purpose is to provide financing to suppliers – not to the company administering the program (also known as the buyer).

Furthermore, it’s important to remember that supply chain finance is part of a multi-pronged working capital optimization strategy. The first prong is the extension of supplier payment terms by the buyer – from 45 to 90 days, for example. The second prong offsets the negative impact on participating suppliers by allowing them to sell their invoices to funders (typically large financial institutions) for early payment. Using the example above, this allows the supplier to receive payment for an invoice on, let’s say, day 10. Meanwhile, the buyer doesn’t have to pay the funder on the invoice until day 90, improving each party’s working capital position. In other words, while supply chain finance improves cash flow for the buyer, its true function is as a supplier financing tool.

To maintain off-balance sheet status, the program must demonstrate that funders have the same rights to receive payment that the supplier had, and no more, at the point of sale of the invoice from the supplier to the funder. If a funder exerts any additional leverage to guarantee payment from the buyer, the transaction will be subjected to direct lending rules and the funds will be reclassified as bank debt.

The result of the foregoing analysis is that supply chain finance is one of the only ways companies can materially improve cash flow for themselves and their suppliers without having a negative impact on the balance sheet. It remains off-balance sheet while it improves both buyer-side and supplier-side cash flow and financial health.

VP, General Counsel

Published November 22, 2016