What is supply chain finance?

Supply chains now stretch across the globe, connecting multinational buyers with suppliers in a wide range of countries. But as these supply chains get bigger and more complex, businesses are finding a new and unexpected problem to deal with – working capital (sometimes totalling millions of dollars) gets trapped inside the supply chain itself.

How can your business optimise cash flow, ensure suppliers get paid early, and reduce the inherent risk associated with any global supply chain? A supply chain finance solution could be a potential option. Take a look at our supply chain finance definition to find out more.

Supply chain finance definition

Supply chain finance is a term describing a set of financial solutions that can help provide suppliers with working capital while ensuring the stability of the supply chain for buyers. But what is it? Essentially, supply chain finance refers to a situation where a buyer will approve a supplier’s invoice for financing from a third-party intermediary, usually a bank or outside financier, meaning that the supplier gets paid more quickly than they would otherwise.

Quick note – supply chain finance is also referred to as reverse factoring or supplier finance, so if you see those terms crop up in your research, just know that it’s all referring to the same basic concept.

How does supply chain finance work?

The mechanics of supply chain finance solutions involve three key players: the supplier, the buyer, and the financial institution. For supply chain finance to work, you also need to use a supply chain finance platform, while the credit rating of the buyer will generally need to be higher than the supplier (so that they can source capital at a lower cost).

Here’s a simple guide to how the whole process actually works:

1. After a buyer places an order with a supplier, the supplier will fulfil the order and send an invoice to the buyer.

2. Then, the buyer approves the invoice and confirms that it will pay the financial institution when the invoice reaches maturity.

3. Next, the supplier sells the invoices to the financial institution for a discounted rate and receives payment immediately.

4. Finally, when the invoice reaches maturity, the buyer pays the financial institution for the value of the invoice.

What are the benefits of supply chain finance?

There are several important benefits associated with supply chain finance. On the supplier side, the benefits are very clear. Suppliers receive early payment, which means that they’ll be able to free up cash in their supply chain much sooner than would otherwise be possible. Because of this, supply chain finance solutions can help suppliers to navigate difficult economic conditions that may otherwise have affected their ability to deliver in a timely fashion.

There are also plenty of benefits on the buyer side. By improving the supplier’s cash flow, the buyer can improve their own supply chain’s stability and reduce the risk of late deliveries or substandard products. Supply chain finance solutions are also a great way to foster a good relationship between buyers and suppliers, in contrast to the competitive dynamic that usually exists between the two parties.

Supply chain finance vs. factoring

When you’re looking at different financing solutions for your business, you’ll probably come across invoice factoring at some point. It’s important to understand the differences between supply chain finance and invoice factoring, so that you can make the right decision for your business. So, how do these terms differ from each other?

Essentially, invoice factoring is a tool that businesses use to receive money from outstanding invoices as soon as possible. If, for example, you’re in need of working capital, you’d simply sell the invoice to a third-party as a way of receiving a short-term cash injection. In most cases, invoice factoring is a type of small business loan because a company’s accounts receivable acts as collateral.

So, when it comes to supply chain finance vs. factoring, the differences are clear. Whereas invoice factoring requires a supplier to sell its receivables to a third-party for a discounted rate, supply chain finance is a financing solution that’s initiated by the buyer, giving suppliers the opportunity to receive early payment for their goods/services.

We can help

GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.