What is Supply Chain Finance (SCF) and How Does it Work?

Supply chain finance is a range of financial solutions that help improve liquidity in supply chains. It allows buyers to extend their payment schedules to suppliers while allowing both big and SME suppliers to receive their payments on time or in advance. 

In this article, we will learn about supply chain finance, its working mechanism, and how it strengthens business relationships between buyers and suppliers. 

What is Supply Chain Finance?

Supply Chain Finance (SCF), also known as reverse factoring, is a service designed to improve cash flow for both buyers and suppliers by facilitating early payments on invoices while allowing buyers to extend payment terms. It helps the management of the cash flow between buyers and suppliers by automating transactions, from invoice initiation to bill payment. A range of technological solutions come into play to automate electronic transactions, invoice monitoring and payments between buyers and suppliers. 

Usually, factoring is arranged by the supplier. But, in SCF, the process is initiated by the buyer. On behalf of the buyer’s good credit score, a financial institution releases early payment to the supplier against a small transaction fee. This leads to reduced financing costs and quicker fund access for suppliers. On the other hand, buyers enjoy long credit terms to pay off their balances. 

How Supply Chain Finance Works?

Supply Chain Finance (SCF) is based on making early payments to suppliers while at the same time giving buyers an extended deadline to pay off their bills. Let’s understand this working mechanism in detail. 

First, the buyer signs an agreement with an associated supply chain finance provider, which may be a bank or a financier. Next, suppliers are invited to join the programme. The process begins when the supplier provides products or services for which an invoice is sent to their buyers. The buyer signs on the invoice and notifies the supplier that they have the option to wait for the payment to be due on the invoice date or ask for early payment to be made. Suppliers can choose to cash out their invoices for early payment by selling or trading their receivables to funders on the SCF platform. 

This system is a win-win for both parties. Purchasers receive better credit terms than before; on the other hand, sellers enjoy faster access to working capital without compromising on the relationship between the two parties. 

SCF can be implemented across organisations in global supply chains as it is easier to onboard tens of thousands of suppliers through digital financing solutions available today. Some SCF platforms also offer a dynamic discount that allows buyers freedom of payment while providing early payment to suppliers.

Supply Chain Finance Process

The SCF process starts when a buyer makes a purchase from a supplier. After the supplier raises an invoice that comes with payment conditions such as 30, 60, or 90 days, the buyer signs the invoice. The supplier can then choose the buyer’s affiliated SCF platform to receive an early payment. A funder, for instance, a bank, makes the payment to the supplier on behalf of the buyer in exchange for a small service fee. On the due date of the invoice, buyers pay back the funder. 

Benefits of Supply Chain Finance

SCF facilitates easy credit management, and here’s how it benefits both buyers and sellers:

For suppliers:

• Improved Cash Flow: Suppliers receive early payments to enjoy a surplus working capital
• Enhanced Cash Flow Predictability: Suppliers can forecast their future cash flow more accurately because they are paid earlier than expected.
• Risk Reduction: Sellers transfer payment risks to third parties in exchange for receivables from their own balance sheets to increase their liquidity.

For buyers:

• Optimised Working Capital: Buyers can delay payments for as many cycles as they can without putting pressure on their suppliers.
• Strengthened Supply Chain Relationships: Timely payment release puts the buyer in the good books of the supplier.
• Supply Chain Stability: Adequate funds for smooth operation reduce the chances of supply chain disruptions.

Additional benefits:

• Multi-Funder Access: Modern SCF platforms can help companies maintain the global supply chain network with thousands of suppliers around the world while providing access to multiple funding sources.
• Bank and Funder Advantage: SCF enables originators such as banks and finance providers to sell receivables at a lower price and obtain profits through sales to other investors or receive the same when paid in full.

Example of Supply Chain Finance

For example, Company A ordered goods from Supplier Z. The goods were conveyed, and an invoice containing 30 days' terms was delivered. Should Supplier Z require money earlier, early payment can be arranged with the help of the SCF partner of Company A. The SCF partner releases payment to Supplier Z as soon as possible against a small service charge. Company A will enjoy improved supplier credit terms and will receive an extra 30 days to pay off the debt over the previous deadline. This form of relationship enhances Supplier Z’s cash flow position and, at the same time, enables Company A to exercise efficient working capital management for a mutual gain advantage.

Supply Chain Finance Market in India

The market of supply chain finance in India has grown significantly due to an urgent need for efficient working capital management, and availability of government support. There are risks such as long payment periods and high credit costs that affect Indian companies, particularly MSMEs. However, through SCF, these companies benefit from lower costs and efficient payments. Also, government-sponsored programs, such as TReDS, have helped more than 10,000 MSMEs get better cash flow and timely access to funds. 

Increased growth is also seen from the aspect of digital transformation as SCF platforms are widely implemented especially among the SMEs. It is estimated that the Indian SCF market will experience a CAGR of 20% by fiscal Year 2027 due to the increasing propensity for digitisation and awareness. 

Supply Chain Finance Companies in India

The overall market of SCF in India is supported by many big names that offer better working capital solutions to enterprises. Prominent digital players like Cashinvoice, Credlix and KredX have designed solutions that help MSMEs get quick and cheap financing using their buyer-seller linkage. Using these platforms and backed up by innovative technologies, suppliers can be paid early, and buyers can delay their payment terms in equal measures with no impact on their balance sheets.

Furthermore, established large banks such as HDFC Bank and ICICI Bank have jumped into the SCF market, providing end-to-end solutions for not only large businesses but smaller organisations as well. Initiatives such as TReDS promoted by the government have been beneficial for increasing SCF use, especially for MSMEs.