A guide to supply chain finance

What is supply chain finance?

Supply chain finance (or 'supplier finance') is a type of cash advance. Similar to invoice finance, it's based on the credit rating of companies in the supply chain.

It's a way for smaller businesses to benefit from the higher credit scores of their buyers and for buyers to lengthen their payment terms. That might sound confusing — here's how it works.

How does supply chain finance work?

Large multinational companies are highly likely to honour invoices from suppliers. That means the suppliers that work with them can get 100% of the value advanced from a lender, minus a small fee, once the buyer has approved the invoice for payment — because, at this stage, the risk of non-payment is low.

A breakdown of supply chain funding

• The supplier issues an invoice to the buyer.

• The buyer confirms that the invoice has been approved for payment to the lender.

• The supplier gets the value straight away (minus a small fee).

• When payment is due, the buyer pays the lender.

In this way, the supplier's cash flow is stabilised because they get paid within a few days, rather than waiting for the expected 'payment due date (which could be as long as 120 days).

Meanwhile, the buyer simultaneously benefits because they have effectively extended their payment terms without negatively impacting their suppliers. After all, if the lender takes the payment delay, the supplier gets paid within a few days, and the buyer's working capital is untouched until their extended payment terms are over.

Benefits of supply chain finance

Supply chain finance is mutually beneficial for both buyers and suppliers because it helps both parties stabilise their cash flow.

• Suppliers get similar benefits to invoice financing— they get paid within a few days rather than waiting for extended payment terms.

• The cost can be lower because supply chain funding is based on the buyer's credit rating.

• Buyers can extend their payment terms, i.e. delay paying suppliers for longer than average, without directly putting pressure on their suppliers.

• It's the lender whose working capital is affected — leaving both the buyer's and supplier's working capital free to use for other business purposes.

Supply chain finance is a collaborative process — the lender helps both the buyer and the supplier, and all three parties have an arrangement together. That's why supply chain finance is not the same as invoice finance, even if it might seem similar from the supplier's point of view.

Supply chain finance vs trade finance

Smaller buyers who receive goods from suppliers can fund these transactions using trade finance, as long as they are financially strong and work with creditworthy suppliers. This is typically done using Letters of Credit and/or cash upfront from large lenders that guarantee the payment to your supplier.