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What are the basics of supply chain finance?

Old models of financing are giving way to supply chain finance, a technology-enabled approach that helps suppliers get paid early and buyers get more time to pay.

Suppliers want payment as soon as possible, retailers and other buyers often want more time to pay suppliers, and...

banks need ways to make money with low risk. Enter supply chain finance, a technology-enabled set of processes and a win-win for everyone involved. At its simplest form, here's how it works: Financial Institution X is the guarantor for Supplier A, but at the better credit rating of the typically larger Buyer B. If Supplier A needs to be paid sooner than the invoiced payment is due, Financial Institution X pays Supplier A, minus a preferential rate of interest. In turn, Buyer B can get more time to make the invoice payment.

Rather than suppliers being on their own to seek out what are often higher interest loans, with supply chain finance, both supplier and buyer have some benefits that make it a very attractive approach. Old models of financing, such as factors that provide short-term loans based on contracts or guaranteed receivables, are giving way to this lower-cost model. Indeed, supply chain finance has been growing in the last decade and shows no signs of slowing. It represents a more strategic relationship between buyers and their typically smaller -- but important -- suppliers, since the practice enables them to work more collaboratively. The growing supply chain finance market is also propelling a boom in its related job market.

What are the benefits of supply chain finance?

A supply chain finance service relies on a cloud technology platform that is shared among the buyer -- which is the customer -- the supplier and the bank. Using this service, the bank can see the various supply chain key milestones and feed capital to the supplier to fund operations. The customer shares the purchase order (PO) data with the bank as part of its demonstration of credit worthiness. When the supplier needs cash to meet the terms of the PO -- for example, for hiring labor or buying supplies -- it provides data about its work schedule and capital requirements to the bank. Since the work is transparent to the bank, it assesses a lower risk to the loan, and thus lower interest. (See Figure 1 for key milestones.)

The benefits extend all around: a lower cost of capital keeping the supply chain costs in check; a well-funded supplier to keep the supply chain running on time; and solid low-risk loans, often which can get paid back early to the bank.

supply chain lending milestones
Figure 1. Examples of potential visibility points and lending milestones across the P2P order lifecycle.

How do you get started?

Since supply chain finance is a process based on an agreed-upon relationship between the customer and supplier, a conversation between the two has to start. Most international banks and experienced technology partners who support supply chain finance processes can provide the details, legalities and so on.

Then, since supply chain finance depends on technology, the supplier and buyer need to engage the appropriate technology platform to enable communication with the financial institution. Firms like GT Nexus (an Infor company) have many connections to international banks already and have been doing this for a decade or more. From a platform perspective, supply chain finance is a broad set of B2B transactions that depends on customers' needs. A company can start with some very basic functions. As the supply chain finance program proves successful, the company can choose more nuanced -- and higher benefit -- processes such as early payment programs.

A few things the platform needs:

  • Electronic B2B communications for sales, contracts, POs, invoices, advanced shipping notices and the financial transactions. Most electronic data interchange in supply chain management systems only cover the basic supply chain functions, but don't include the financial and payment. So, most supply chain platforms are not up the task of these added transactions.
  • Some workflow and production tracking, so supplier purchases and inbound material expense, production milestones, and outbound shipment to the customer are tracked and validated. These are triggers to provide capital to the supplier.
  • Payment automation. Payment is triggered by comparing orders, invoices, packing lists, proof of delivery, inspection certificates and goods receipts to ensure date-certain and accurate payment to suppliers and lenders without manual intervention.

Advanced programs also exist to offer even more capabilities.

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This was last published in November 2015

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