• Demystifying Supply Chain Finance in B2B Commerce  

Demystifying Supply Chain Finance in B2B Commerce

Supply Chain Finance (SCF) continues to be a hot topic in the world of B2B transactions, although for many companies, SCF can mean many different things to many different people. Thus the topic of SCF has become somewhat confusing. The purpose of this blog is to provide some clarity to our readers by defining SCF. From there, we’ll point to some new areas that SCF has evolved to provide new powerful and strategic tools for buyers and suppliers to manage the business.

At the highest level, SCF is the utilization of working capital within a single supply chain. While this is an overly simplistic definition of a deeply confusing, misunderstood topic, it will serve us well as we talk about several key components that are now tied to SCF.

The basic component of SCF is Supplier Finance, which is the traditional way of thinking about SCF. It begins with the typical interaction between buyer and supplier, whereby the supplier sends an invoice to the buyer, who then authorizes the supplier to be paid. Supplier Finance kicks in when that invoice is turned into an approved invoice, and instead of the buyer, the bank steps in to pay that invoice immediately, or within the term of the deal. In this case, the bank takes the risk of non-payment and sets its fee structure based on the risk profile or credit standing of the buyer. In this situation, the buyer can take advantage of published or fixed discount rates for earlier payment of a supplier invoice – typically a 2% discount for a 10 days earlier payment – and maximize supplier discounts using other people’s money.

The advantage of Supplier Finance for the supplier is that payment is guaranteed, DSO is reduced, and cash flow can be optimized. For the buyer, it provides the highest and best use of working capital, increases DPO, and enables improved purchasing incentives with suppliers. Supplier Finance creates a win/win situation in that it reduces risk in the transaction, accelerates the business, enhances the terms and conditions of the deal, and improves the overall relationship between buyer and supplier.

A decade ago, “Supplier Finance” as outlined above was essentially the key mechanics of SCF. However, with a recent influx of new innovations, products, services, and technologies in the areas of finance, purchase-to-pay (P2P), and order-to-cash (O2C), the entire scope of SCF has become much, much more. For example, consider Dynamic Discounting, which has recently come into vogue. The promise of Dynamic Discounting is that it enables buyers and suppliers to “dynamically” renegotiate payment terms with a flexible discount schedule based on need. So instead of a fixed discount schedule provided by suppliers in advance, buyers and suppliers are now able to use technology to collaborate in real-time to arrive at the best terms possible for a specific transaction.

A scenario where Dynamic Discounting becomes interesting is where the buyer may have an excess of Free Cash Flow (FCF) to dispose at the time, where seeking a 5%-10% discount on an open supplier invoice would provide a higher return on FCF than if the money was held or invested elsewhere. Using Dynamic Discounting, the buyer is now able to reach out proactively to the supplier to suggest an earlier payment in exchange for better terms. On the flip side, the supplier may have a shortfall in cash flow, and rather than seek traditional funding from another source, Dynamic Discounting enables the supplier to proactively offer the buyer a better discount on an open invoice in exchange for faster payment. Once Dynamic Discounting is established in the relationship, it can easily be repeated, and the buyer and supplier have a new powerful strategic tool to better manage the business. Win/win.

As outlined, Dynamic Discounting is a twist on the traditional definition of SCF. New innovations, products, services, and technologies in the areas of P2P and O2C are fueling this evolution. Along this line, unlike with traditional SCF, a bank may or may not be the ultimate financier for the transaction either. In fact, today, the financier could now be any number of entities including hedge funds, HNIs, or others that are in a position to supply funds immediately. Democratizing and automating sources of cash for SCF is still in its infancy, but there is high interest from financiers to participate in the lucrative SCF area to achieve extraordinary returns on capital with limited downside risk. As you can see, Dynamic Discounting enables buyers and suppliers to gain the benefits of traditional SCF as outlined above, but in a way that is more automated, collaborative, and real-time, benefiting both parties simultaneously.

Another evolution in SCF is what is known as Pre-Shipment Finance. This is just fancy jargon to describe the act of when a bank not only funds the purchase of raw materials early in the business cycle, but also the cost of manufacturing products based on these raw materials. For reliable companies, the risk of doing business is less, so the bank can theoretically issue higher and less expensive credit to those companies. While this benefit could provide incentives for smaller companies to fill orders more quickly and efficiently, it also comes with the inherent risks associated with handling non-invoiced money lending. Pre-Shipment Finance is another example of how SCF has evolved, and adds confusion to how SCF is defined today.

Supply Chain Finance continues to be a hot topic in the area of B2B transactions for a reason. Buyers and suppliers are looking to gain financial efficiencies, find new and cheaper pockets of liquidity, and tap into the collaborative power of the supply chain. As such, SCF as a category will continue to evolve and expand fueled by new innovations, products, services, and technologies, and enable new powerful and strategic tools for buyers and suppliers to manage the lifeblood of their business – cash.

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