A mobile phone manufacturer relies on a large number of small suppliers for parts to manufacture its self-branded handsets. Under current market practices, these suppliers typically wait 120 days from invoice issuance to receive payment. Supply chain finance products can help buyers and their suppliers meet working capital, cash management and risk mitigation objectives.
Trade finance involves a broad set of products that support the needs of many trading ecosystem participants. These include commodity traders, ship brokers (who match cargo to ships) and containership companies. These businesses help facilitate global commerce and import-export activities. Often, buyers require that their suppliers provide them with credit terms for payment (time to pay). These terms may be 30-60-90 days, which means that sellers are at risk for non-payment by the buyer.
In order to mitigate this, trade finance products such as purchase order financing allow for a financial institution to advance a percentage of the total purchase order notional value to the supplier prior to shipment. This helps reduce the risk of payment default and improves working capital efficiency for both the buyer and the seller. It also does not show up on the company’s balance sheet as debt which allows for better cash flow management. Moreover, this type of finance is scalable and flexible to meet the requirements of various buyers.
Reverse factoring is a financing method that enables buyers to purchase goods and services from their suppliers on credit while allowing them to receive payment from the supplier sooner rather than later. This enables buyers to eliminate the need for invoice financing and other supply chain finance products such as dynamic discounting or supplier financing and improves cash flow while helping businesses avoid financial disputes with their suppliers.
Buyers can provide this service to their suppliers by establishing a factoring or forfaiting program whereby the financier purchases the invoices from the buyer on their behalf and pays them at a lower cost based on the buyer’s credit rating. This helps to preserve the relationship between buyer and supplier, reduces supply chain risk and gives a strong negotiating position to the procurement team. For the suppliers, it helps them to receive their payments quicker which reduces the risk of supply disruption and allows them to optimize their cash flow and working capital. They also benefit from reducing days sales outstanding and improving their cash forecasting.
Suppliers often face deferred invoice payment terms of up to 120 days, which can put a strain on cash flow. This is especially true for rapidly growing companies that need to invest in staff, facilities and equipment. They may also have a difficult time qualifying for loans from banks due to limited or poor credit history. This type of supply chain finance allows a financier to purchase future payment obligations from Suppliers and provide them with immediate working capital.
The Supplier submits an invoice to the invoice-discounting company, which uses it as collateral for a short-term loan. The financier typically charges a fee to cover the risk, costs and interest. The purchaser can then choose which invoices it wishes to pay early, and these will be remitted directly to the financier rather than to a long list of suppliers. This can simplify AP and reduce the work of chasing late payments. The invoice-discounting company then settles with the Supplier after the agreed payment term, minus a small fee.
liquidity management solution programs can be structured to address both the peaks and troughs in working capital. For example, a landscaping company might find that its cash flow spikes in spring and summer but declines over the winter and fall when revenues are lower. In this scenario, the landscaping company could partner with a financial institution to offer financing on its accounts payable invoices during these slow periods. The financier would pay the suppliers early, and the buyers would reimburse the financier at a later date, typically one that falls on or near the original due date of the invoice.
The supplier may be able to take on a new customer, while the buyer can keep its current customers and benefit from having access to cheap funding during slow times. This arrangement can be especially beneficial when the financial health of a buyer is important to a supplier. Moreover, this type of program allows a supplier to extend payment terms without depleting its own credit lines.
In the dynamic realm of supply chain management, the evolution of finance products has been pivotal. Innovative solutions have empowered businesses to optimize their cash flows, reduce risks, and enhance collaboration across the supply chain. As these products continue to evolve, they promise to play a pivotal role in fostering efficiency, resilience, and growth for companies of all sizes.