Supply Chain Finance Explained

Written by Conrad Ford on March 20, 2019

Updated June 10, 2019

Supply chain finance broker on his phone

Small businesses often struggle with getting approved for finance and loans, especially if they are newly established. This is usually because they have not yet had the chance to build up their own credit score.

Global supply chains stretch across the world, and companies are able to unlock the working capital within these by using supply chain finance. It gives businesses the opportunity to access funding that they might otherwise not be approved for. This guide explains what supply chain finance is, how it works and what the benefits are to businesses.

What is Supply Chain Finance?

Supply Chain Finance is a type of cash advance based on the credit rating of companies within their supply chain. Smaller businesses that may not have a good credit score for themselves yet can take advantage of the credit scores of their buyers.

In most cases, well-established and larger companies with good credit ratings are much more likely to be accepted for a loan or finance. If small businesses have the opportunity to work alongside these companies and come to a mutual agreement with them, then it can help get a quick turnaround on payment.

Small business owners face a whole range of difficulties in their day-to-day running of the business and finding themselves with large and unexpected costs can really throw a spanner in the works – maintaining a steady cash-flow is difficult enough without this added cost.

Not only does Supply Chain Finance allow small businesses to get their cash-flow issues under control but gives them the freedom to free up any additional capital they may have for business growth. Supply Chain Finance allows small businesses to gain finance opportunities built on the relationships they have formed between with existing buyers.

Large companies are unlikely to default on paying their invoices and taking a small cut on the costs in exchange for faster payment can be very worthwhile for small-business owners.

How does Supply Chain Finance work?

A business ultimately receives a financial loan based on the strength of its buyer’s business – the buyer identifies businesses within its supplier base that would benefit from faster payment terms, agreeing to pay the company’s invoices to the supplier in exchange for a discount.

Supply chain finance is a popular option for larger businesses that want to improve the cash flow situation of their small business suppliers. The supplier is consequently paid much more quickly by the buyer, giving them a more fluid cash flow and the opportunity to grow.

Upon agreeing to the terms, invoices are sold to a bank or other type of lender, at a reduced rate and paid immediately to the supplier, while buyers are given additional time to pay off the invoice. Buyers benefit from the reduced fee and suppliers from quick invoice payment – a win-win situation for both sides of the deal.

When arranging supply chain finance, it is essential that both the buyer and the supplier have trust in one another. A supply chain finance relationship can only really be established if the two companies have worked together previously, as the chain relies on both parties committing to the terms of the lender. Failing to comply with the supply chain finance agreement can have serious consequences on a business.

If one side of the agreement fails to follow through with their side of the deal, then the obligation will be placed on the other party to fulfil the payment. Lack of trust between the two will result in a failed attempt at supply chain finance.

What are the benefits of Supply Chain Finance?

For suppliers, the obvious benefit of the process is that they are able to access their money much quicker than if they waited for invoices to mature naturally. This faster payment process will give a much quicker cash conversion cycle and ultimately help the business grow over time.

As a consequence, their overall balance sheet looks much more positive and puts them in a better financial position for the future. This can help the supplier business with being able to acquire other forms of finance in the future.

As well as the initial benefit of having a more stable cash-flow, this type of finance also provides its users with a longer-term benefit. Supply chain finance supplies its customers with a strong credit profile. Using this third party credit fund means that companies will be able to make outgoing payments on time, protecting any relationships they have formed and consequently strengthening the business profile.

Buyers will also benefit significantly from supply chain finance as the process opens them up to longer payment terms, which can be beneficial if they themselves have buyers who they await payment from.

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