The biggest skills in business may be touted to have the right product, say the right things to its audience, to get the numbers. While all these are in fact true the back-end ‘operational’ stuff, the blood in the veins are equally if not more important. What happens when a business buoyant with rising demand gets ambitious and takes on a large order? What happens when the buyer delays his payments? Vendors start demanding for dues that the producer has not yet received. If they do not have the funds, their business could be badly damaged and in some cases go bust. Every business must have ambition, big ones but they must also have a strong plan in place to ensure timely payment to suppliers who fuel their growth. This is all the more important when the payment terms of buyers are much longer than that for suppliers. Fortunately ambitious businesses can adopt Supply Chain Financing methods and keep growing while keeping suppliers and customers happy.
Finances tied up in the pipeline can now be unlocked in favor of the producer for a small fee by bankers and financiers. Supply chain finance is also known as supplier finance or reverse factoring.
Supply chain financing helps producers by ensuring early payments against invoices, while buyers can continue to optimize their cash flow. The producer can thus pay their suppliers on time, resulting in a win-win situation for all parties.
How does it work?
To understand how Supply Chain Financing works we are going to see the methodology used at PrimeRevenue, a provider of supply chain forecasting.
Supplier sends the invoice to the buyer. Once the buyer approves the invoice they upload it to a platform, which can be accessed simply through a web-browser. Once this is done, the supplier can choose to wait till maturity date or sell the invoice to a funder who will collect the receivables from the buyer when the invoice matures.
If the supplier chooses to encash the invoice before the maturity date, they can after paying a small transaction fee. Payment is received within a day. The interest rate is fixed based on invoice maturity date and therefore buyers risk not sellers risk. This is why financing rates are much lower than factoring or other financing solutions.
When the invoice matures, the buyer pays the funder.
How then is Supply Chain Financing different from dynamic discounting?
In Dynamic Discounting the buyer offers shorter payment terms than their usual payment cycle. By shortening the payment period, they seek discounts from the supplier. There is no third-party involved.
In supply chain financing a third party funder is involved. The funder pays the supplier the invoice amount for a small fee and the buyer can maintain their payment cycle thus optimizing their working capital.
Siemens has a Supply Chain Financing platform for its suppliers called Orbian.
The benefits Siemens points to for using Supply Chain Financing are:
- Cash flow improvement: a two-day payment cycle
- Working capital optimization: increases liquidity and reduces debt/equity ratio
- Cost reduction: reduced account receivable costs compared for suppliers
- Transparency of cash flows: Suppliers can see the status of their invoices
The supply financing rate in this case study about Siemens is EUR LIBOR + 1.2 % p.a.
The discount rate for a discounted value receivable of EUR 997, 333 is 0.3%. The supplier received payment in 10 days instead of the usual payment cycle of 90 days.
The requirements of a Supply Chain Financing programme
According to PriceWaterHouse Coopers a good supply-chain financing system has certain requirements to perform well:
- Quick confirmation of invoices by buyer
- Standard terms of payment across the group
- Standard payment cycles
While Supply Chain Financing seems too good to be true, it is not without some pitfalls.
- Bank failure or withdrawal
- Risk of reclassification i.e of trade payables becoming bank loans
- Funding limits being put in place by supply chain financing facility
- In case of dispute with supplier, invoices once confirmed cannot be disqualified
Conversely a well-functioning supply chain financing means healthier buyer-supplier relations, smoother functioning of the supply chain with high reliability and improvements in cash management, working capital management and cost.