This article is a contribution from our content partner, PrimeTrade

Supply chain finance allows businesses to get their suppliers paid quickly without affecting their own accounting or cash flow.

Sometimes it is called SCF, supplier finance, reverse factoring, or dynamic discounting. These different labels all describe a similar process:

1. Suppliers provide goods or services.
2. Suppliers invoice the buyer, giving the buyer time to pay (e.g., 60 or 90 days).
3. The buyer approves the invoice for payment.
4. A financier then pays the supplier immediately with a discount to cover the cost, and the financier takes over the invoice.
5. The buyer pays the invoice later to the financier.

In dynamic discounting, the financier is the buyer itself. All of the discount agreed to by the supplier for early payment is earned by the buyer using its own cash. In this situation, the invoice is simply paid early, and the buyer generates additional income.

A win-win

SCF is a win-win for buyer, supplier, and financier:

• The supplier gets paid upfront for a discount.
• The buyer gets to pay later, maximising its operating cash flow.
• The financier earns a return on the cash it provides.

Supply chain finance enables cash to move more efficiently through the supply chain:

• Suppliers get paid quickly, reducing their risk and helping their cash flow.
• Buyers owe the money anyway, so SCF is not extra debt.
• Buyers are usually better credits than suppliers, so the financing charge is lower than the supplier’s normal borrowing cost.

Basic supply chain finance

Basic supply chain finance is the simplest and most common form of SCF today.

A software platform is used to coordinate the three parties involved (buyer, supplier, and financier).

• When the buyer approves the invoice, the invoice is uploaded to the SCF platform.
• The supplier logs into the platform, sees its approved invoices, and can take the money immediately for a discount.
• Every day, the platform sends a payables file to the financier, who pays suppliers directly less agreed discounts.
• The buyer pays all of the invoice to the financier, and the financier’s cost is covered by the discount.

3 things to know about basic SCF

1. It is a very successful product with volumes in 2022 reaching US$2 trillion.
2. That’s despite basic SCF being quite inconvenient for both buyers and suppliers. Running programs can involve significant manual work for buyer finance teams, whilst uptake from suppliers can be low because early payments are often not that early.
3. As a result, the typical basic SCF program is quite small—under 100 suppliers.

Is SCF/reverse factoring a good thing?

Yes.

Supplier finance, or SCF, provides all the included suppliers with the same access to liquidity regardless of location and size. There is a reported $2.5 trillion per annum funding gap for smaller suppliers in emerging markets that supply chain finance can address.

But basic SCF needs an upgrade to work better. That’s because early payments are not very early, and SCF programs can be painful to run in practice.

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