Supply chain finance has taken off in recent years, fueled by companies’ greater focus on working capital management, as well as banks’ retreat from lending in the wake of the financial crisis.
“Almost every business is becoming increasingly global and that stretches their supply chain out a lot,” noted Craig Jeffery, managing partner at Atlanta-based consultancy Strategic Treasurer.
Finance teams try to improve their working capital metrics by waiting longer to pay suppliers. But “when a larger player is trying to free up money by extending terms, that creates extreme hardship for suppliers,” Jeffery said.
Supply chain finance can cut through that dilemma. Companies can offer financing to their suppliers based on outstanding receivables, which lets a the company to extend its days payables outstanding and improve its working capital without making suppliers wait longer to be paid.
“The capital play is massive for treasury people,” Jeffery said. “The ability to improve your capital position is great, and you can do that without breaking your suppliers.”
The term supply chain finance covers different approaches to extending credit, such as reverse factoring, in which a company arranges financing based on invoices from suppliers that it has approved for payment, or dynamic discounting, in which the company offers to pay the supplier early at a discounted rate. Jeffery estimated that about 20% of companies currently use some form of supply chain finance.
Strategic Treasurer recently published a report on supply chain finance that notes the rapid growth in supply chain finance but cites a “lack of awareness” among corporate finance departments. In a recent interview, Jeffery and Isaac Zaubi, publications manager at Strategic Treasurer, discussed some of the points that finance practitioners should consider if they’re planning to implement a supply chain finance program.
Choosing a Provider
Companies selecting a supply chain finance provider should look at three aspects: access to capital, the size of the vendor’s network and the capabilities of the vendor’s system.
For starters, does the company want to use its own cash to fund the supply chain finance program or does it plan to rely on a third party for the cash?
“Supply chain finance providers out there today offer a range of models,” Zaubi said. “Depending on their funding needs, companies can choose a solution.”
Most fintech solutions have multiple banks that provide funding, he said. If companies want to use their own cash, “they could leverage a dynamic discounting program where they’re able to fund almost the entirety on their own.”
Companies should also check what businesses already use each supply chain finance platform, to see which of their counterparties are on the network.
“That’s a key component in how the onboarding works,” Jeffery said. “If you give them your vendor list or customer list, they will run a match to show which ones are already on there.”
Joining a supply chain finance platform that already includes a number of the company’s vendors expedites getting started. “The more customers or vendors you get on the network, the easier it is to manage the entire process, and get the most financial value out of it as well,” Jeffery said.
Companies should also look at the capabilities of the platform itself. “How easy is it for a vendor to self-serve, update payment information, communicate about payments?” Jeffery said. “Process efficiencies have often been overlooked because people went to supply chain financing for the financing part of it. But the efficiencies that are being built in are generating some pretty significant yield.”
Banks vs. Fintech
While banks dominate the supply chain finance market, Strategic Treasurer’s report notes the growing role of fintech platforms. It cites a McKinsey report estimating that as of 2015, banks had about 85% of the global supply chain finance market, while fintech firms had 15%. In contrast, in 2005, banks had 95% of the market and fintech just 5%.
“Banks are leading in terms of access to capital,” Jeffery said, but noted competitive pressure from fintech firms.
“Fintechs have been driving the efficiency, the networks, and represent a bit more of an open model,” he said. “They can tap into multiple credit providers. They’re more nimble and flexible.”
Zaubi said fintech providers of supply chain finance may also allow more of a company’s suppliers to participate.
“Using a fintech solution, most companies are finding they’re able to onboard as many suppliers as they want,” he said. “With banks, programs are only available to a certain number of suppliers, those deemed least risky and most profitable.”
A supply chain finance program involves a number of different units of a company, including not only finance and treasury, but procurement, sales and accounts payable. Procurement’s priorities may differ from treasury’s, but Jeffery stressed the need for all the different departments to work together to make the supply chain finance effort successful.
Strategic Treasurer’s report suggests that companies form a working capital council that includes representatives from AP, procurement, IT, sales, treasury and the legal team. A survey conducted by Strategic Treasurer found that 17% of companies have a working capital council and another 8% plan to implement one by 2019.
Global Rules and Regulations
Companies that work with suppliers in many parts of the world will have to contend with various countries’ different rules and regulations.
“If they have a lot of suppliers that are distributed across the world, there are a lot of different regulatory challenges that come into play,” Zaubi said. “Onboarding a supplier in China is going to look a lot different than onboarding a supplier in Latin America.”
Companies should rely on their own legal departments as well as the regulatory team at their supply chain provider, he said. “They can provide guidance and insight as to the most appropriate method moving forward to get the documentation. That’s one of the biggest aspects when implementing a global supply chain.”