Introduction - Everything you need to know
Supply chain finance (SCF) is a term used to define the financial relationship linking the buyer and the supplier (seller). It covers a wide spectrum of funding activities, which are either:
Buyer driven programs such as
- Trading/Purchasing Cards
- Traditional Consumer type Credit Cards
- Reverse Factoring
Supplier (seller) driven programs such as
- factoring,
- invoice discounting,
- inventory financing
Program definitions:
Trading/Purchasing Cards
B2B Trading Cards enable trade purchases to be funded in a similar way to a consumer credit card transaction. It is underpinned by a commercial loan facility from the Buyer’s financier/lender against the Buyer’s credit. This allows funding to be directed to where the actual credit risk rests (as opposed to existing forms of working capital finance where security and risk rests with the Supplier (Seller). This buyer driven program has been developed with the financier/lender in mind, as a means to attain greater visibility in the supply chain transactions that they are funding.
The system requires a series of member (Buyer and Seller) interactions from both sides of the supply chain. It progresses through a series of authorising steps using digital certificates stored on smart cards for user authentication.
It ensures a validation and verification process has occurred between all parties at each sequential stage of the trade transaction. This gives the two Financial Institutions, the knowledge and comfort that the Buyer and seller have indeed transacted. It provides supply chain finance from the time a purchase order is agreed on, to the eventual receipt of payment from the end customer.
A key benefit is that the buyer (not the lender) takes the responsibility for the supplier (seller) - for example, dealing with adjustments for goods returned or faulty.
Reverse Factoring
Similar to the supplier driven program, factoring, except in this case its one buyer with multiple sellers. Reverse Factoring relies on the supplier (seller) selling their invoice for goods and/or services provided. The buyer has to confirm to the financier/lender, in a legally binding format:
- The validity of the Payable
- That the Payable will be paid without deduction or set-off at a date certain time.
However under this model the discount rate is dependent on the buyer’s credit standing. Cost of funding is generally based on the buyer organisation, which may be cheaper than that available to suppliers (sellers). This buyer driven program is a competitive market – with many banks offering this service for large buyers. Suppliers (sellers) can receive 100% of invoice value early therefore reducing the supply chain risk. The program relies on supplier (seller) selling receivables. A key benefit is that the buyer (not the lender) takes the responsibility for the supplier (seller) - for example, dealing with adjustments for goods returned or faulty. As a result it is less complex than other structures and funding.
Traditional consumer type Credit Cards
Business agrees contract with Credit Card provider. The credit card is issued to specific employees to provide a controlled solution and buying power for adhoc expenditure. Buyer provider set limits on spend per transaction and per card on a month by month basis. It’s a payment mechanism as the case of the traditional consumer card. Its an excellent tool for consolidating non working capital low spend / high numbers of suppliers (sellers). Accounts Payable efficiency benefits. As the loan limit is generally small, its only applicable for ad-hoc non working capital low spend suppliers (sellers) such as stationary, petrol, entertainment and travel. Transaction fees charged by card provider always go against the supplier (seller) and invariably its very expensive financing for the supplier (seller).
Factoring
This is where the factor purchases the supplier’s (seller’s) accounts receivable, with or without recourse, and assumes the responsibility for the buyer’s financial ability to pay. In the case of non recourse factoring, if the buyer goes bankrupt or is unable to pay its debts for credit reasons, the factor will pay the supplier (seller). When the supplier (seller) and the buyer are located in different countries the service is called "international factoring". Generally International Factoring is done on a non recourse basis.
Invoice Discounting
Invoice Discounting is the purchase by the Discounter of the accounts receivables of a business with or without recourse. The sales accounting functions are retained by the business. The buyers are unaware of the involvement of a Discounter.
Inventory Financing
Inventory financing can take many forms and is again a well established offering in the market. This can range from inventory financing solutions provided by financial institutions through to supplier (seller) led programs where supplier (seller) will self fund the cost of inventory with buying organisations, typically for an increased cost on the goods. These programs are typically referred to as consignment stock or vendor managed inventory within manufacturing and production environments.
The supply chain finance buyer driven market
Several options and solutions are available in the market today, each with a variation on the offering.
But there is a growing demand for SCF mechanisms and volumes are increasing as are the number of providers.
Before deploying an SCF buyer driven solution it is important to understand the drivers. Traditionally it has been used by buyers or suppliers (sellers) to address adverse market conditions. These conditions have led many an organisations’ purchasing department (buyers), to demand extended payment terms with their supplier (seller)s. Suppliers (sellers) are being forced in turn to look for alternative solutions to receive their payment in a timely fashion. The most commonly recognised forms of supplier (seller) driven SCF in the marketplace (e.g. factoring and invoice discounting) have often had a stigma attached (wrongly in Octets view) when buyers discover suppliers (sellers) are using them.
Within a SCF buyer driven solution there are typically four involved parties:
- The buying organisation - the “buyer”
- The organisation supplying goods / services - the “supplier (seller)”
- A technology platform “the technology or system”
- A funding institution – financier/lender
It is important in the case of a buyer driven program, that the correct parties are engaged to ensure that the benefits are realized. SCF is often an “afterthought”, a reaction to an instruction by treasury / finance departments to extend supplier (seller) payment terms. To deploy an SCF buyer driven program successfully, it is important that it is viewed as an initiative that requires the involvement of key departments within the buyer
SCF buyer driven program does not replace the service agreement between buyer and supplier (seller). It does however impact on the commercial agreement where payment terms are affected or supplier (seller) discounts are being employed. Depending on the requirements of the buyer or the supplier (seller), appropriate choices can be made on the selection of the best SCF buyer driven program to be deployed.
A technology platform is required to bring together the payment mechanism and triggers. This sits between the buyer, the supplier (seller) and the funding mechanism. Technology solutions differ across the marketplace.
All Reverse Factoring type versions are EIPP (Electronic Invoice and Payment Processing) systems. They handle data only and don’t allow electronic versions of paper documentation as in the case of the Trading Card program. The principal five activities performed by the technology in reverse factoring are:
- Purchase order generation, approval and receipt
- Goods delivery/received data
- Invoice generation and receipt
- Invoice matching, reconciliation and approval
- Payment processing.
On the other hand the technology involvement in Trading/Purchase Card programs, provides the confirmation, validation and authentication of specific and critical stages of the trading transaction with no change to the buyer/seller form of transacting and there is certainly no interference by financiers in the transaction either.
Depending on the SCF buyer driven program deployed, the technology may be provided by an independent solutions provider or by the funding institution. Many of the banks offer their own platforms for both buyer and supplier (seller) driven financing. The traditional consumer type credit card program provides much less Information due to limitations at the acquirer end and it is rare that the system will identify a purchase order, invoice and delivery. It’s simply a payment mechanism for a purchase.
In buyer driven programs, any funding is based on the buyer’s credit standing as the buyer accepts the risk of managing the supplier (seller) and it is the obligor to the funder. Under supplier (seller) driven program, the funder’s recourse is only to the supplier (seller).
Transaction fees are set based on the buying organisation credit standing and in the case of both reverse factoring and the traditional consumer type credit card, are incurred by the supplier (seller).
Other Observations on buyer driven Supply Chain Finance programs
- Complexity and uncertainty of the accounting for SCF mechanisms is unhelpful
- Accounting treatment is generally seen as key by some large buyers.
- General level of understanding of SCF products is poor. Often people hold a negative view of SCF (narrowly viewed as invoice discounting). In particular there is a need to educate analysts and commentators about the merits of SCF.