A Reference Guide to Trade Finance TechniquesSupply chain finance
Supply chain finance is a technique which
allows companies to facilitate the provision
of credit to their suppliers. It allows stronger
credits to leverage their own credit status,
so that finance can be provided to suppliers
at lower rates than they can usually access
themselves. It has developed because
companies are focusing on the need to
support other parties in their supply chain,
for two related reasons: to ensure their own
operational activities run smoothly, and
to be protected from the risk of a crucial
supplier failing financially. At the same
time, technological changes have made it
possible for companies to share information
along a supply chain, making supply chain
finance more available. It is now easier, for
example, for suppliers to see the status of
submitted invoices.
How it works
For a supply chain finance structure to work,
one entity in a particular supply chain must
have a significantly stronger credit status
than most of its suppliers. In effect, the bank
or other financial firm (the ‘financier’) provides
finance to the suppliers on the strength of the
credit standing of the buying company. The
counterparties benefit because the funds are
made available at rates which they cannot
access themselves (this may be due to a
poor credit rating or a lack of liquidity in their
home markets).
The buying company can create supply
chain finance structures to support its
suppliers and achieve a mutual benefit.
Companies recognise that if one of their
suppliers fails, this will have an operational
impact on their own production and may
result in their own failure to meet obligations.
Most supply chain finance structures
involve financiers extending credit to their
suppliers on the strength of approved invoices.
Under such a structure the company would
agree normal supply contracts with a number
of suppliers. The company’s core suppliers
would be invited to participate in the supply
chain programme. Assuming the supplier did
agree, it would have to meet certain conditions
to participate, such as the ability to upload
invoices electronically to a dedicated platform.
Once the supplier has been accepted into the
programme, it could start to access financing.
Under the terms of a typical structure,
the supplier would supply the company in
line with their contract. At the same time,
it would invoice the company, usually by
uploading an invoice electronically onto the
company’s trade platform. The invoice would
be processed by the company’s accounts
payable team and, within an agreed period,
either be listed as approved on the platform,
or queried with the supplier.
Once the invoice is listed as approved,
the supplier would have the choice whether
to raise finance against that invoice in the
programme. If the supplier decides to raise
finance through the supply chain finance
programme, it will receive payment from
the financier within a set time period. This
payment will be at a discount to the face
value of the invoice, but will be in full and final
settlement of the contract. This discount, i.e.
the interest charge, will be set relative to the
sponsoring company’s credit rating, which
will be better than the rate the supplier could
achieve if it approached an invoice discounter
on its own behalf. If the supplier does not
decide to participate in the programme on
this occasion, it will be paid the full invoice
amount on the payment due date.
Under the terms of the programme,
the financier will effectively lend funds to
participants along the supply chain. If a
supplier does participate in the structure,
the company will be required to pay the face
value of the invoice to the financier after the
normal pre-agreed period from the approval
of the invoice. In the event the company does
not pay, the bank usually has no recourse to
any supplier participating in the structure.
A supply chain structure provides a
financing solution that is intended to run
for the longer term. It will require significant
investment in technology platforms by the
company offering the solution, although
much can be outsourced to a bank or other
specialist provider. Suppliers need to be able
to submit invoices electronically, which may
also impose an additional cost.