What is Supply Chain Financing?: A Guide For Beginners

Supply chain financing (SCF) is an established practice globally and domestically. The World Supply Chain Finance Report 2022 reported global SCF volume skyrocketed by 38% ($1.80 trillion)in 2021. 

Terms like factoring, receivables discounting, reverse factoring, etc., are not new for businesses, specifically for manufacturing companies. 

The advantage of supply chain financing is that both parties win – buyers (by optimizing the credit period) and suppliers/sellers (by getting immediate payment facilities).

However, the progress of supply chain financing in India has been slower than the other countries. It is mainly due to two reasons:

• Lack of awareness of the SCF products 
• Absence of financial inclusion in the Micro, Small, and Medium Enterprise (MSME) sector.

In this blog, we will have a closer look at the supply chain financing outlook in India, how technology is unlocking new value by innovating more SCF products, and the key trends in the SCF globally and domestically. 

What is Supply Chain Financing?

Supply chain financing means optimizing supply chain processes and transacting by using tech-driven solutions and financing and risk mitigation practices to manage working capital and liquidity requirements.

SCF providers (like banks, financial institutions, and fintech companies) enable buyers and suppliers to use a technology platform to simplify their supply chain financing needs.

An SCF process flow includes key players such as – Suppliers, Buyers, and Supply Chain Financing Providers.

How Does Supply Chain Financing Work?

To understand the process of supply chain financing, let’s take help of an example of a supplier X selling FRP pipes to and the buyer Y who is using it tousing FRP pipes to manufacture high-storage tanks. 

1. Y places an order to buy 150,000 FRP pipes from X
2. X delivers the pipes and sends an invoice to Y. Y promises to pay for the products a few months later. However, X is in need of funds right away.
3. Y takes the invoice to the supply chain finance provider (e.g., banks/fintechs).They receive the funds right away (At predetermined discount rate) from the SCF provider.
4. Y makes the payment to the SCF provider later on the maturity date. 

The advantage of availing the supply chain financing solutions is that they provide a longer credit period to the buyers, provide timely payment to the sellers, and helps SCF providers earn commission/fee. 

Now, let’s see how these supply chain financing players interact to make the financing process smooth.

Diverse Players in Supply Chain Financing

Let’s understand each player in the supply chain financing ecosystem and how they work: 

Key players:

• Buyer requests the supplier to make the delivery of the goods or perform the service requested.
• The supplier fulfills his obligation and demands his invoice payment.
• The supply chain financing provider arranges payment to the supplier. 

We know that buyers, sellers, distributors, and financial institutions benefit from trade and supply chain financing products. 

But, how about we dig a bit deeper.

Supply Chain Financing Benefits

For Buyers	For Suppliers	For Distributors	For Financial Institutions
Increased Credit PeriodBalance Sheet NeutralReduced Cost of Goods SoldMore stable supply chain process Corporate social responsibility	Reduced Outstanding Receivables Decreased finance costsGreater accessibility to cashCertainty about timing and amount of paymentImproved visibility to invoices Credit Risk EliminationBetter Cooperation with buyers	Improved working capital efficiency Accessible Financing Improved Relationships With Suppliers	Increased customer base Improved Long-term Relations with Large BuyersStable, Short-term Low-risk Revenue StreamLow Acquisition Costs and Better Risk Management

Every stakeholder involved in a supply chain financing process benefits from availing the SCF facilities. Let’s look at the key benefits of supply chain financing for buyers, suppliers, distributors, and financial institutions.

For Buyers

1. Buyers get a longer credit period since they pay the SCF provider upon maturity, and hence, get increased days payable outstanding. 
2. Despite buyers using SCF facilities, it does not affect their balance sheet items since it is balance sheet neutral, often called off-balance sheet financing.. 
3. Earlier, the suppliers with cheaper rates would get preference, and buyers used to change them more frequently. However, now SCF creates time difference between product received and payment for the same. This allows buyers to choose the right supplier and create long-lasting partnerships. This brings stability to the supply chain process from supplier selection, receipting, and approval to e-invoicing. 
4. Since the suppliers get fairly selected, it benefits the buyers from a corporate social responsibility viewpoint. 

For Suppliers

• The most important benefit to the suppliers through the SCF products is reduced outstanding receivables, which helps them improve their working capital efficiency.
• Mostly, the buyers enjoy a good credit rating from the finance providers, and the benefit of reduced funding costs reflects in the rates charged by the SCF providers in the form of decreased finance costs.
• Using balance sheet items (e.g., receivables, inventories), suppliers get greater accessibility to the financing. It results in faster access to liquidity and a quicker cash conversion cycle from delivery of goods/services to receiving cash.
• Mostly, the SCF providers are banks or financial institutions; hence, there is a certainty about the payment and the time of payment.
• Suppliers can know immediately which invoices are approved hence, it improves visibility, which improves efficiency for the credit control.
• It is a form of non-recourse financing where suppliers reduce the risks of non-payment (i.e., credit risk) by arranging the finance from legitimate sources (banks, financial institutions).
• Suppliers can cooperate better with buyers due to higher integration across the supply chain process and improve their long-term relations with them.

For Distributors

• Since the distributors get payment extensions from the financial institutions, it improves their working capital efficiency. 
• Distributors have better connections with large manufacturers and can leverage their relations to obtain supply chain financing, allowing greater accessibility.
• The SCF also helps distributors improve supplier relationships through better integration across the supply chain.

For Financial Institutions

• Financial institutions can improve their long-term relations with large buyers since they help them avail extended credit periods by paying their invoices to the suppliers.
• Compared to the other traditional lending products, SCF is a more stable, short-term, and low-risk revenue stream. 
• SCF products offer better risk management and low acquisition costs since they access large data sets and information.
• Since the financial institutions also help the MSME sector obtain supply chain financing easily (through reverse factoring and distributor financing), they experience an increased customer base. 

However, small businesses still have a considerable credit gap in supply chain financing. Let’s see what challenges the SCF address for the MSME sector.

The SCF ecosystem works in association with each other to create innovative and value-added products.

However, more often than not, SCF is used as a synonym of reverse financing.

That is simply not true. 

Let’s see SCF products that are divided into two parts – receivables purchase and loan-based financing.

8 Types of Supply Chain Financing Products

Supply chain financing products can be divided into 2 categories:

The receivables-based financing or receivables purchase is a type of loan suppliers obtain by selling their receivables to the finance providers. 

Whereas loan-based financing products are loans and advances obtained on the underlying asset (e.g., receivables, inventory, etc).

Receivable Purchase 1. Factoring 2. Receivables discounting 3. Reverse factoring 4. Forfaiting

Loan-based Financing 1. Distributor finance 2. Pre-shipment finance 3. Loan against inventory 4. Loan against receivables

Receivable Purchase

Receivable purchase mainly include factoring, receivables discounting, reverse factoring, and forfaiting. 

1. Factoring means the supplier sells his receivables (debtors) to a finance provider at a discount called ‘factor.’ Basically, in factoring, the finance provider takes care of the supplier’s receivables and recovers money from his debtors at a charge/fee. 
2. Receivables discounting means obtaining a loan against the accounts receivables from the finance providers. Many suppliers have a significant balance available as receivables, and finance providers give loans on such amounts after eliminating any doubtful or bad debts. 
3. Reverse factoring (payable financing) means the supplier obtains an advance from the finance provider to pay off his payables to receive discounts. 

4. Forfaiting means obtaining medium or long-term finance by the exporters from finance providers by selling receivables to them. Exporters mainly do this to receive immediate cash for their exports and reduce their burden of recovering money from the importers.

Now, let’s see what loan-based financing is about.

Loan-based Financing

Loan-based financing can be obtained by the buyer or supplier selling their assets (e.g., inventories) to the finance providers. It includes:

1. Distributor finance:obtaining loans for distributors from the finance providers by selling receivables or other current assets to cover the holding costs of goods for re-sale and maintain liquidity. 
2. Pre-shipment finance means a loan provided to the exporter to facilitate the export before its shipment, including purchase, manufacturing, and packing. Also known as a packing credit, It facilitates the execution of the export for the importer.
3. Advance against inventory means obtaining a loan for holding the inventory, and the finance provider uses the inventory as security.
4. Advance against receivables means obtaining a loan for trade receivables to receive payments early, meet liquidity requirements, and allow customers to pay at their convenience. 

While the receivable-based and loan-based products are quite similar, their purposes differentiate them from each other. 

Now that we have covered covered the products, let’s understand how the supply chain financing works.

Small Business Supply Chain Financing: A $4.7 Trillion Untapped Market

With a global credit gap of $4.7 trillion, the MSME sector still faces many challenges in obtaining supply chain financing. Mostly in low-income countries, the supply chain finance inclusion is relatively poor. Reasons being

• Lack of awareness about the SCF products
• Lack of trust in the services offered
• Absence of credit history to be eligible for loans
• Cumbersome and costly application processes

In the last 5-7 years, the supply chain financing outlook has changed massively, thanks to the technological advancements. The supply chain finance fintech companies provide finances to small businesses efficiently and cost-effectively. 

The old methods of obtaining supply chain finance in India are outdated since they are majorly accessible to large corporates. Let’s see why old SCF methods don’t work with today’s digitally native customers. 

Why Old Supply Chain Financing Paradigms are No Longer Valid

Earlier, the SCF processes was quite unfair to the suppliers and buyers had the monopoly to change their suppliers frequently. Moreover, buyers and suppliers did not have many options to avail of SCF services. 

Let’s see why it was so:

• Impact of VUCA economy: The global markets are rapidly changing, impacting every country to deal with the VUCA (volatility, uncertainty, complexity, and ambiguity) economy. Today a particular method of availing SCF finance has worked well, but tomorrow it may not. 
• Demographic changes: Economic circumstances attached to any geographical location are different. Globalization has facilitated ease of trade and finance, but the demographics are not similar. Thus, it leads to different buying behaviors of the customers. 
• Increasing B2B customer requirements: The line between B2C (business to customer) and B2B (business to business) is evaporating, resulting in more B2B customer requirements and the need to innovate new SCF capabilities and approaches.
• Rise of e-commerce activities: E-commerce has become so efficient that it has increased customer expectations regarding personalization, transparency, and real-time information. Thus, the need to increase visibility in the SCF processes is rising.
• Increase in political turmoil: The political uncertainties (BREXIT, trade wars) have been around for years, and it has required the SCF methods to be smooth, efficient, and flexible, which the old methods lack. 
• Social media influence: Social media provides critical information on the global markets for the sustainability of the supply chains. The old methods of supply chain financing are, thus, outdated in terms of providing sustainable supply chain financing. 
• Explosion of digitization: The digitization of various business processes has brought a lot of uncertainty. It results in the shortening of the technology lifecycles that makes it unclear whether a technology that works today will continue to work for their products in the future also or not.

So, What Does a Good Supply Chain Financing Look Like?

Any industry (e.g., manufacturing) with significant spending on suppliers to procure raw materials and other goods must strengthen its SCF process by integrating a procure-to-pay (P2P) strategy. 

Successful integration of the SCF process from procurement of goods to payment should have the following steps:

(below image can be taken as reference)

Supply Chain Financing FAQs

What is the difference between trade finance and supply chain financing?

Trade finance is a type of financing that facilitates invoice payments by issuing a letter of credit (LC) upon presenting necessary documents (bill of lading) to the finance provider. 

Trade finance is majorly used for exports and imports where the suppliers have less control over the invoice payment processes. In contrast, supply chain finance is an easy business loan that mainly works on invoice factoring, among other methods (loan or advance against inventory, receivables).

Supply chain financing vs. factoring – what is the difference?

Supply chain financing provides the easiest way to add liquidity to the business using invoice factoring, payable purchase, loan against inventory, etc. 

Whereas factoring refers to discounting the invoices to receive early payment. 

What role can NBFCs play in the SCF landscape in India?

A recent amendment in the Factoring Regulations Act, 2011, has allowed non-deposit-taking NBFC – investment and credit companies (NBFC-ICCs) to provide factoring services upon fulfilling certain conditions to enable financial inclusion. 

What is invoice discounting vs. supply chain financing? 

Invoice discounting is an arrangement of selling invoice payments to the finance provider to receive early payments at a pre-defined charge called a discount. 

In contrast, supply chain financing refers to obtaining finance in various forms (loans, advances, invoice discounting) to improve business liquidity and working capital management. Thus, an SCF includes invoice discounting as one of the methods to obtain finance.

Does the supply chain include purchasing?

Yes, the supply chain involves purchasing/procuring goods and managing their transformation into finished goods from procure-to-pay and order-to-cash. 

What is supply chain finance vs. securitization?

Supply chain finance is the simplest form of obtaining finance on the receivables, inventories, payables, etc., to improve business liquidity. 

Securitization is a more complex receivable factoring that includes mortgages, auto loans, etc. Both are loans on an underlying asset, but securitization has more complex requirements than supply chain finance.