A Profitable Route through Supply Chain Finance

In a pool game, bank shots are probably the most satisfying to watch. Nothing matches the elegance of a cue ball bouncing off one corner, glancing against two or three balls, then tapping a third ball into the opposite corner pocket. A different kind of bank shot – supply chain finance (SCF) – can have similarly satisfying results. Establish an SCF facility, and in a single stroke you can optimise working capital, stabilise your supply chain and give suppliers the opportunity for greater financial stability.

What SCF Does

SCF emerged as a solution to an inherent conflict between buyers and suppliers: buyers want to pay later, suppliers to collect earlier.

In the short term this practice usually benefits the buyer, but in the long run aggressive delays in payment terms can hurt both parties. Particularly in a difficult economy, the buyer’s ‘win’ can be a Pyrrhic victory, increasing overall supply chain costs as well as potential service disruption. Long delays in payment can damage relationships, lower service quality and lead to price increases as suppliers try to reduce their own working capital risks. So what can the treasury department do about it?

SCF offers a solution, giving the supplier the opportunity to get paid earlier at a discount to full payment without tying up the buyer’s capital on the date the supplier is paid. It also usually gives the buyer the leverage to negotiate a longer payment period with the supplier, pushing the terms out, say, from 60 to 90 days, yet reduce the debt ratio because the money paid out through the finance facility is generally treated not as debt but as a trade payable.

How does it Work?

Whether you call it reverse factoring, supplier finance or SCF, the structure of an arrangement works as shown in figure 1.

Figure 1. The Mechanics of Supply Chain Financing:



REL Consultancy SCF fig 1

Source: REL Consultancy

As per step 1, the process commences when the buyer submits an order and the supplier delivers the goods. Next, on delivery, the supplier sends the invoice to the buyer (or uploads the invoice electronically via electronic data interchange (EDI) or email).

As per step 2, the supplier may do nothing and wait to the standard agreed settlement date or, alternatively, decide to sell or ‘trade’ the approved receivables to a financial institution (FI) in return for a discounted advance payment (step 3). If traded before maturity, 100% of the funds (less a financing fee) transfers to the supplier’s bank account. At payment term date, the buyer then pays the FI the full amount, as per step 4.

While not a cost-free exercise for the supplier, this is generally cheaper than borrowing money directly from the bank while awaiting the buyer’s cheque. The financing rates are generally based on the buyer’s risk, not the supplier’s, although the supplier pays interest on the loan.

Since funds from the financing institution are advanced based on the buyer’s promise to pay on the original maturity date, financing rates are based on the buyer’s risk (and therefore credit rating) and the supplier’s.

A Win-Win Situation

Everyone involved in the transaction benefits from this mechanism. For the supplier, SCF frees up trapped liquidity, allowing for better financing at a lower cost. For the buyer, SCF provides an instrument for negotiating better trade terms with suppliers at no cost to itself. The FI also gets some secure, recurring business. Apart from financial benefits, SCF also:


  •  Increases transparency in the supply chain.
  •  Helps improve buyer-supplier relations.
  •  Provides the opportunity to fully automate procurement and accounts payable (AP) processes.
  •  Helps manage the credit risk in the supply chain.
  •  Enables a more straightforward reconciliation of payments with invoices. 

Buyers Gain Leverage

For buyers, SCF frees up cash and provides leverage to negotiate extended payment terms without squeezing suppliers. The interest rate arbitrage between large buyers and smaller, less creditworthy suppliers often makes it possible for the buyer to negotiate price discounts, extended payment terms or both. On an annual spend of €1bn, assuming a current average term of 30 days that could be extended to 60 days, a buyer could free up €82.2m in cash.

Another key advantage for the buyer is that the financing structure is not treated as debt for balance sheet purposes, but as a trade payable which isn’t considered leverage. This can translate eventually to a lower rate for financing over time.

Suppliers Win, too

Using an approximate average cost of capital of 7% for suppliers and 4% for buyers, suppliers could reduce their finance cost by up nearly a third by using SCF, assuming early payment is requested 10 days after the invoice date. The longer the term the bigger the effect, since the buyer’s lower interest rate comes to bear for a longer time.

Suppliers gain in other ways. An SCF facility usually means a more predictable and flexible cash flow for suppliers, and often a better customer: The buyer frequently ends up more committed to the relationship after setting up the SCF, because the terms are better than those the open market offers.

Setting up the Shot

Phase one: Feasibility and business case (1 month):
Companies seeking to set up an SCF mechanism must ask two key questions: do I fully understand my supply base and do I have the right technology platform or banking partner?

The best way to fully understand a supply base is to conduct a supplier segmentation. This exercise enables the buyer to target suppliers with specific initiatives that are relevant to their situation. A buyer might group its supply base into four buckets based on value/opportunity and market complexity.

Figure 2. Example of Supplier Segmentation:



REL Consultancy SCF fig 2

Source: REL Consultancy

Next, to determine the most appropriate strategy and approach (whether unilateral or negotiated), the buyer should perform a risk analysis. Based on the supplier base segmentation and risk analysis, the four classes shown in figure 2 could divide into eight classes comprising four low-risk suppliers and four high-risk suppliers.

Strategic and bottleneck suppliers for both levels of risk could be approached with an SCF initiative, while vendors outside those categories could instead be offered payment term extensions and discounts.

After deciding on a technology platform provider and financial partner(s) for the SCF programme, a quantification based on supplier segmentation and targeted strategies should be made to create a business case.

Phase two: Implementation (3-4 months):

A typical SCF implementation lasts three to four months and requires strong collaboration between finance and procurement. In a large company, an implementation should be made on one or more pilot locations, then rolled out to different locations or units inside the company.

The first and often toughest step of implementation is to define the requirements and start adapting the enterprise resource planning (ERP) systems. At the same time, targeted marketing campaigns should be launched to educate vendors about the new facility.

Following the marketing campaigns, prioritisation of the supplier base should be done based on the classification and risk analysis from phase one. After prioritisation, the company should start enrolling suppliers in the SCF programme. Who the buyer chooses to enroll is a key success factor in implementation. If the supplier base is properly understood from the analysis and segmentation, the chances to enroll the right vendors for maximal benefits increase significantly.

Just before adaptation of the ERP systems, a live test on a limited sample should be conducted to identify any flaws in the process. At the same time, the training for the enrolled suppliers can start and continue until implementation ends.

Finally, the SCF is rolled out across the company, incorporating insights gained in the pilot programme.

The Benefits

SCF is an innovative way to use a third-party lender and a third-party technology partner to improve both the buyer’s working capital position and the suppliers’ financial stability. However, SCF is not right for every supplier or supply chain – buyers should select their supplier partners in an SCF relationship with care. It takes only one difficult vendor to destroy a programme. The good news is that once the structure is built, an SCF can help the financial position of both buyer and supplier even as it increases the stability of the supply chain.

The Fine Print

An SCF partnership doesn’t suit every supplier relationship. It’s important to understand your supply chain risks. Smart buyers perform supplier segmentation and risk analysis to establish where they have leverage and where they should leave well alone.

The solution itself requires due diligence also. An SCF arrangement involving a third party technology provider could involve sensitive information being stored on external servers, out of the control of buyer and seller. Integration with internal ERP systems may be complicated. The arrangement may also lock the buyer into a particular financial service provider.

According to David Gustin, president, Global Business Intelligence and editor of
Trade Financing Matters
: “Accounting is also fairly complex. Although SCF is long-established, whether a buyer’s payables under an SCF programme are considered bank or trade debt for balance sheet purposes is still not entirely clear, since the International Financial Reporting Standards (IFRS) offers no guidance in this area.

“If the buyer confirms to the FI that he will pay at maturity of the invoice regardless of trade disputes or other rights of offset he may have against the supplier, then it he gives a higher commitment to pay to the FI than he owes to the supplier. Accounting regulations may treat this as bank financing, not a trade payable. In that case, how buyers handle chargebacks (subsequent shipments) and how they treat payment confirmations as part of their accounting processes become key considerations.” Mr Gustin adds that typically in an SCF programme that complies with auditors’ regulations the following procedures are followed:


  • The buyer is not guaranteeing a payment to the bank over and above his contractual obligations of the underlying trade contract, which in itself constitutes a promise to pay up on the invoice.
  • The agreement between the bank and the buyer is separate from that between the bank and supplier.
  • The bank determines the discount rate, not the buyer.
  • The bank is not involved in discussions between buyer and supplier about increased payment terms or reduction in cost of goods sold.
  • The bank does not share any interest revenues from the discount with the buyer.

Obviously, any SCF structure should be reviewed by the buyer’s auditors before implementation.

Finally, buyers should keep in mind that not all buyer-supplier relationships are conducive to SCF. A minimum transaction volume or frequency is often required, and the supplier should also have a robust and quick process in place for releasing the invoice to the buyer, such as with EDI or electronic invoices. This is particularly true if the payment term is expressed as a number of days after invoice date.

Complications often arise from the buyer’s invoice handling and matching process. In order to approve the invoice, the buyer must check there is a three-way match of the invoice, the goods receipt note and the purchase order. The longer the buyer takes to match the information, the less the benefit of discounting the invoice in advance of the regular payment date. A well-structured process – with e-invoicing or self-billing, sound ordering processes with the PO correct and available, and quick and electronic logistics data interchanges with real-time or same-day note of goods receipt – should result in invoices that are automated and approved within one or two days.

SCF also commits the buyer to a high standard of payment. Adopting SCF means never paying late. If the buyer is playing month-end games with numbers, such as delaying payments, or is just a bad payer (intentionally or due to weak AP processes), SCF will be an expensive proposition. For this kind of buyer, adopting SCF only makes the situation worse. SCF without structured payment terms can actually hurt the buyer’s cash flow.


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