Supply Chain Finance – Evolution, Significance & Way Forward

Supply Chain Finance (SCF) is relatively recent thinking in Supply Chain Management (SCM) literature. Major Interest in SCF has steadily increased since the past decades and especially during the global financial crisis of 2008. 

Before considering the concept of SCF, it is essential to understand the broader concept of SCM and acknowledge the main developments that are shaping the way that both physical and financial supply chains are managed. SCM is well established within large organizations and offers a competitive advantage in terms of reducing the cost of goods and simultaneously improving customer service.      

Traditionally SCM was referred to as the functions of logistics, transportation, purchasing and supplies, however, the evolution of SCM has shifted the focus to different aspects of SCM such as the issues of integrated risk management sustainability, levels of competition, etc. Firms around the world struggle to find ways to cut costs while maximizing the efficiency of their working capital so as not to fall behind the current market developments and ensure their viability. The concept of SCF is one of the most promising tools for financing firms, however, it gains the significance after the burst of the economic crisis when it became widely used for businesses of all types and sizes.

There are two broad types of supply chain finance models in the market which can be described as “corporate or buyer initiated” and “supplier or vendor initiated”. The buyers are always looking for the very best payment terms from suppliers,  which means requesting for credit extensions and paying their invoices at a much later date. The longer buyers can extend supplier invoices past the due dates, the more working capital they will have available. Hence, by extending payment and credit terms, buyers utilize their working capital in other ways that benefit their business. However, suppliers need access to more frequent capital, take care of expenses such as raw material, labor, rent, etc. With an average delay of more than 35 days, many suppliers in India are of the opinion that due to these payment delays they needed to take additional measures to correct cash flows. Financing this gap can become very expensive and time-consuming. Setting up credit facilities with traditional financing institutions can take a long time and in most cases require security and collateral which is generally limited to the majority of the vendor base. Also, the suppliers’ creditworthiness/years in business has a significant role to play in their ability to raise working capital. This generally limits the amount of capital that can be raised. 

Supply Chain Financing options become attractive for vendors by offering a form of working capital finance that provides liquidity that is primarily used to fund vendor receivables. The financing company pays the supplier full amount of any outstanding invoice before due date, once it is approved by the buyer and as long as the vendors are willing to provide a cash discount or accept a discounting rate in line with their creditworthiness. For vendors, the cash discount or discounting cost means a slight reduction in gross margins and in return they have the benefit of raising the capital without the need for any security, collateral or delay. Moreover, in most cases there is no recourse on the vendor. In other words, if the buyer fails to pay, the vendor is not held liable to repay loan. The fund provider relies on the strength of the corporate business and creditworthiness and can pay the supplier invoices with utmost confidence. Freeing up cash flow and working capital reduces pressure on vendors, while simultaneously eliminating the need to borrow at unaffordable interest rates which in turn is good use of liquidity from the supply chain point of view. 

In uncertain interest rate environment today, all businesses are constantly looking out for new ways of funding, investing and risk prevention, hence supply chain finance can provide them with a viable source of liquidity. A major USP of Supply Chain Finance is that when executed properly, it is beneficial for all the parties, since both buyers and suppliers depend on each other to keep the supply chain moving.  The other advantages are, early payment reduces financial dependence on buyer, it reduces the cost of capital by leveraging buyer’s credit rating, it increases certainty of cash flows & minimizes investment in working capital, finally increasing the stability of supply chain. To substantiate further, supply chain finance is not a loan but it’s an extension of the buyer’s accounts payable and is not considered financial debt. For suppliers, it represents a true sale of their receivables.

While supply chain finance has been around for years; technology and financial innovation has made it more effective, more efficient and easier, which means that benefits are now available faster and to a much wider range of companies than ever before. Even organizations now have realized the importance to adapt the altered ecosystems created by modern technology. The technology can be integrated with ERP systems that are already in use by the company, thereby automating the entire process and eliminating the need to have a large number of human resources working on it. These platforms are built for scale and can be easily replicated over a large number of clients and their vendors.

Though we see supply chain finance gaining significance, there are certain challenges or roadblocks too, some of them are:

  1. Unpredictable cash-flows resulting delays in financial transactions, due to lack of automation in the payment processes; 
  2. Human Resources further breaking down due to lack of training, lack of experts in relevant domain, etc.;
  3. Lack of proper infrastructure;
  4. Absence of common platform for financers;
  5.  Diversion of funds by the borrowers.

Way Forward

With the current economy, India is moving from offline platform to online sales, the banks have huge potential to fund different supply chains. Banks now have an opportunity to fund on forward and backward integration along with value chain and some of the banks have already initiated this. Automation will be the key factor in terms of both integration and flow of information for Banks and other stakeholders. Technology may link the buyers, suppliers and Banks within one web-based system making the process more flexible and robust. Blockchain technology will play important role in reducing the wait time for physical documents to be exchanged between parties. Electronic transferral of documents will provide greater transparency for the end customer as to where the end product is sourced.