The economy is global. Raw materials mined overseas are shipped to factories thousands of miles away, and then the finished goods are sold around the world. It is this globalization—and the credit crunch many organizations feel—that drives renewed focus on working capital management. It is impossible to run a business without working capital, and as buyers look to extend the value of their capital through deferred payment terms and suppliers aim to get paid faster, significant issues can arise.
As a practice, the idea of supply chain finance (“SCF”) is designed to mitigate risk in accounts payable and extend the usefulness of the enterprise’s working capital. In the past, it was perceived as ideal only for small and mid-size firms or those with poor credit ratings, but lately many healthy organizations and large multinationals have looked into the tactic to unlock liquidity and improve their capital utilization.
The market impact is tremendous—stringent new banking regulations and conservative credit models make buying necessary materials challenging—and supply chain finance alleviates the sort of financial pressure that has become so common in recent years. There are some misconceptions about the practice, however, which is why Ardent has pulled together five things every AP organization should know about supply chain finance.
- Supply chain finance is similar to, but not the same thing, as factoring. In traditional invoice factoring, suppliers sell their invoices to third-parties in order to get paid faster than standard payment terms allow. The interest rates provided to suppliers tend to be fairly high and based on the credit of an organization with uneven cash flows. Supply chain finance operates much the same way, and is often called reverse factoring, but the difference is the lender’s credit decision is based on the buyer’s financials instead of the suppliers. This is a key difference because buyers tend to have steadier cash flows than suppliers and can, as a result, receive better rates.
- Supply chain finance does not have to use third-party capital. While traditional SCF operates on the concept of using a third-party lender to pay suppliers at the point of invoice approval, many organizations put up enterprise money to offer a supply chain finance program themselves. These enterprises tend to be on the larger side, and the money is kept in a separate account, but it still operates like supply chain finance.
- Supply chain finance is for more than strategic suppliers. SCF programs have traditionally been a little costly to implement, and as a result tended to be used for only a small percentage of suppliers—typically those of strategic value. This is no longer the case in the wake of emerging technologies that have streamlined access to SCF capabilities and programs. Now, buying organizations can extend the same SCF possibility to any supplier willing to participate.
- Supply chain finance allows buyers to extend days payable outstanding (“DPO”) longer than standard payment terms. In general, a longer DPO is considered a sign of financial health; it signifies that the enterprise can easily delay payment and conserve cash. However, traditional methods of extending DPO can sometimes impugn the supplier relationship. An SCF program eliminates this dual pressure because suppliers are paid at the point of invoice approval, typically with a third-party’s capital. Meanwhile, the buying organization owes the invoice amount to the lender, and can generally negotiate longer payment terms.
- Banks are not the only ones offering supply chain finance solutions. Supply chain finance is often offered as part of the treasury solutions category at many large financial institutions. Large banks and other lenders are not the only solution providers in this category, however. Solution providers such as Ariba, Taulia, and Kyriba also offer supply chain finance options, and Tradeshift has a joint solution with Citibank.
The dance between a long DPO and maintaining supplier relationships is a challenging one. Buyers want a long DPO to show financial health, but they also do not want to risk receiving less favorable contracts from suppliers because they delayed payment one too many times. Supply chain finance is an effective way to eliminate this concern and is, in fact, almost a total “win-win” formula in the buyer/supplier relationship. New technologies have also opened up the possibility of creating an SCF program to a wider array of buyers, and made the system even more attractive overall. Because of this, the true value of SCF lies in driving financial value from the supply chain while also preserving supplier relationships.