Every business, irrespective of its size, requires working capital to function properly. Working capital is the financing needed by a business to cover its day-to-day expenses. Thus, it is crucial to maintain the working capital balance in supply chain management.
A simpler and faster way to ensure this is to implement the supply chain finance method.
What is supply chain finance?
Also known as reverse factoring, supply chain finance is a set of technology-based solutions that allows the suppliers to receive early payments on their invoices. It is a form of supplier finance that improves business efficiency and lowers the financing cost for buyers and sellers.
In simpler terms, supply chain finance is a type of cash advance that depends on the buyer’s credit rating.
123Financials sharing some of the essential things to keep in mind while using the supply chain finance method are:
- Supplier finance is not regarded as financial debt. Instead, it is an account payable extension for the buyer.
- Supply chain finance works the best in the case of the buyer having a better credit rating as compared to the seller.
- Supply chain finance methods can be used by all companies regardless of their size and credit ratings.
- If the suppliers want to get paid early, then they have to pay only a small discount as the supply chain finance cost. On the other hand, the buyers do not have to pay any fee to extend their payment terms.
How does supply chain finance work?
- To fill out the transaction details, the supplier sends an invoice to the buyer.
- The buyer verifies with the lender that the invoice has been authorised for payment and informs the supplier.
- The supplier has all-time access to the supply chain finance platform to see all the currently approved invoices.
- Except for a small financing fee or discount, the entire invoice total is electronically transferred to the supplier’s bank account straight away.
- The buyer is responsible for paying the full invoice amount to the lender or the supplier on the maturity date.
What are the benefits of supply chain finance?
Using the supply chain finance method is a win-win solution for the buyers and suppliers due to the following reasons:-
- Optimisation of the working capital
Supply chain finance allows the suppliers to get paid for the invoices sooner than they would have otherwise. This will lead to a decrease in their Days Sales Outstanding (DSO).
In addition, many businesses also choose to establish supply chain finance initiative to harmonise supplier payment agreements.
Due to this, there is an improvement in both buyers and suppliers’ working capital position.
- Low financing rate
The financing rates of supply chain finance are meagre than the other financial solutions because they are only based on the buyer’s risk. This is because the money borrowed from the financial institution is provided to the buyers based on their promise to repay the original maturity date.
- Quick access to money
Due to supply chain finance, the suppliers don’t have to wait for the standard payment due date to get paid. Instead, they get quick access to the money that they are owed.
The suppliers are also better positioned to unload their products and receive immediate payment from the intermediary financing body because they can get the money sooner.
- Extension of the payment terms
Supply chain finance gives the buyers the option to extend their payment terms. As a result, they receive additional time to pay off their balances without negatively impacting the supplier.
- Accurate cash flow forecasting
Supply chain finance allows the suppliers to receive a more reliable understanding of the timing of the incoming payments. This will help them in forecasting the future cash flows accurately.
- Improved supply chain health
Supply chain finance ensures that the chances of a possible supply chain disruption are reduced, leading to the smooth running of the operations.
In addition, a smooth supply chain will also lead to an improvement in the buyer-supplier relationship, which will allow the buyer to have a stronger negotiating position in the future.
Drawbacks of the supply chain finance:
While supply chain management is intended to benefit both parties, it is still a complex solution.
It can be tough to comprehend the agreement’s details and how the buyer might apply discounts and the corresponding rate. The supplier also has to go through many steps to receive early payment.
Moreover, some financial institutions might also set a monthly restriction on the number of invoices that will be approved.
Supply chain finance is an arrangement that can serve the needs of both parties in a transaction. It minimises the chances of a supply chain breakdown and improves the efficiency of the buyers and the suppliers. But before using this approach, it is essential to consider all the benefits it offers and its drawbacks carefully. If you need any help with tax advise and suppy chain accounting feel free to contact us.