Supply Chain Finance provides cash flow benefits to the supplier and the buyer

04 Mar 2016 – Supply Chain Finance provides cash flow benefits to the supplier and the buyer

In any supply chain, the cash flows between supplier and buyer are precariously balanced. The supplier needs payment from his buyer so that he can pay his own supplier, who also needs to pay his supplier, and so on. If one party fails to pay, or pays late, it has a domino effect on all the other parties in that supply chain.

An economic downturn such as the one we are experiencing at the moment has two major financial impacts on supply chains:

All participants within the supply chain manage their own working capital as best as possible, by collecting payment from debtors/buyers as early as possible and paying its creditors/suppliers as late as possible; and
Some participants experience cash flow problems, often caused by the very measures taken by the other participants. This causes supplier failure and instability in the supply chain.
Traditional bank funding can sometimes assist, but normally only when larger companies with strong balance sheets are involved. If an SME participates in a supply chain, it will often not be able to obtain bank funding, which then allows aggressive buyers of the SME as well as its suppliers to turn on the screws. In a country where SMEs employ a huge portion of the workforce, this cannot be tolerated because it causes instabilities in the economy.

Supply chain finance (“SCF”) is a popular solution to this dilemma. SCF injects working capital into the supply chain at critical points between buyers and sellers – like a referee keeping two boxers apart to give them some breathing space.

In a SCF arrangement, a financier steps into the supply chain and provides early payment to a supplier based on invoices approved for payment by its buyer. From the supplier’s perspective, it has exactly the same practical effect as offering an early settlement discount to the buyer. However, it doesn’t place any burden on the buyer’s working capital – that burden is carried by the financier.

Practically, the arrangement is a simple top-down approach to invoice discounting:

The buyer provides a list of supplier invoices approved for payment to the financier;
The financier offers early payment to the suppliers;
Suppliers who accept the offer are paid early by the financier, at a pre-agreed discount;
The buyer pays the financier on the normal invoice payment date.
The benefits to the supplier are obvious – cash is king! The supplier has more cash, can pay its own suppliers earlier and negotiate cash settlement discounts or lower prices.

However, there are also huge potential cash benefits to the buyer, other than increased stability of its supply chain:

If a buyer suffers from its own cash flow problems and needs to extend its supplier payment terms from (say) 30 to 60 days, introducing SCF to its suppliers will soften the blow to them and help protect the buyer’s reputation;
A SCF program could assist in price negotiations with its suppliers;
The buyer could form a joint venture with the financier to profitably employ its own cash resources, when available;
The buyer could release a substantial part of its own working capital by arrangement with the financier. For example, instead of paying the financier on the invoice date – say 30 days, it could arrange with the financier that payments would only be made 7 days later – 37 days. This would improve its cash flows tremendously, at no cost because it represents its remuneration for participating in SCF for its suppliers.
Supply Chain Finance is a cost-effective approach to unlocking working capital tied up in the supply chain with benefits to all the participants – suppliers as well as buyers.