By Aniket Bose. Edited by Arjun Chandrasekar.
What is Supply Chain Finance?
Supply chain finance (SCF) is a term that is used to describe solutions that aim to lower a company’s financial costs and improve their business performance for buyers and sellers for sales transactions. SCF carries out its work by automating transactions and tracking invoice approval along with settlement processes from initiation to completion. Under this philosophy of finance, buyers agree to approve their suppliers’ invoices for financing by a bank or any other outside financial institution, and these are often referred to as “factors”.
Since it provides short-term credit that optimizes the working capital of a business and provides liquidity to both parties, SCF offers distinct advantages to all of the participants. While the suppliers can gain early access to the money that they are owed, buyers also get more time to pay off their balances. Both parties of the transaction can use the cash available to them for other projects so that they can keep their respective operations running smoothly.
How does Supply Chain Finance Work?
SCF works the best when the buyer in the transaction has a better credit rating than the seller so that they can access capital at a lower cost. This advantage allows buyers to negotiate better when they are in the process of a transaction with the seller, such as extended payment deadlines. At the same time, the seller can unload their products at a faster rate, so that they can receive immediate payment from the intended buyer. SCF is also referred to as “supplier finance” or “reverse factoring”. SCF encourages there to be a lot of collaboration between the buyers and sellers. This philosophy of finance counteracts the competitive dynamic that typically occurs between buyers and sellers during a transaction. In the end, under regular circumstances, buyers will try their best to delay their payments while sellers are looking to be paid as soon as possible.
Example of Supply Chain Finance
Suppose there is a buyer from a certain company that is seeking to purchase the goods from the seller who is a supplier at another company. Under traditional circumstances, the supplier would ship the goods and then send an invoice to the company where the buyer works, which will approve the payment on standard credit terms of a period of 30 days. However, if the company where the supplier works is desperate for cash, it can and may request immediate payment from the company that buys the supplies, even for a discounted price. If this condition of the transaction is agreed by the buying company, then the company will issue the payments to the supply company, and this then gives the buying company more time for the full payment, for an additional 30 days, it would then be a total credit term of 60 days.
In the end, supply chain plays a huge factor in reducing supply chain risk and helps both sides, buyers and sellers, to optimize their given capital for purposeful uses.
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