Supply chain finance programmes offer a route for suppliers to get their invoices paid early, usually at a low cost. This sounds like a good thing, but recent experience suggests that some supply chain finance programmes may have hidden dangers for suppliers.
How does supply chain finance work?
Whilst there are variations, the basic principle of supply chain finance is:
- Suppliers agree to provide extended credit terms to the buyer, their customer. For example, all invoices are issued with a payment term of 120 days post-shipment.
- The buyer, working with one or more funders, arranges an option for suppliers to obtain an advance in exchange for a small discount.
- This delivers trade credit to the buyer, whilst ensuring that suppliers can access funding early from a third-party funder at a reasonable cost
BUT there are three important questions that suppliers should ask themselves before agreeing to extended payment terms with a larger buyer and relying on earlier payment via a supply chain finance programme:
1. How good is the buyer’s credit?
Supply chain finance programs are arranged on the basis that the funding is provided to the supplier via early payment. It is the supplier who then provides trade credit to the buyer. This is achieved because the supplier’s invoice is issued with a long[er] payment term but the supplier cash flow is protected via the early payment.
BUT supply chain finance does not provide credit protection to the supplier. If the buyer has financial difficulties, the funder will immediately decline to advance funds to the supplier – and the supplier will be left with a long-dated invoice to collect.
Point to check: Do not provide trade credit to the buyer unless you are happy with the buyer’s credit and the payment terms of your invoice are appropriate for the buyer’s risk. Supply chain finance does not remove the buyer credit risk from you.
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Comments: the collapses of Carillion and Abengoa, just two examples, were preceded by the supply chain finance providers involved (banks) pulling their programmes. Suppliers, who were invoicing with extended payment terms, suddenly found that they could not get early payment. In the subsequent insolvency, these suppliers were unsecured creditors and at the back of the queue for recoveries, with more exposure than they would have had if they had been invoicing on shorter-dated terms.
2. How reliable is the funder, how much funding is available?
The availability of funding depends upon the reliability of the funder and the size of the programme. If the funder fails to perform or the amount of funding is limited – the supplier can find that early payment is suddenly not available.
Points to check: Is the funder stable and is the programme big enough?
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Comments: The recent default of Greensill highlights the importance of funder stability. Moreover, the programmes arranged by Greensill were often for buyers that had limited access to funding. So when Greensill failed, some buyers found it difficult to find a replacement. This does not mean the suppliers lost money, but supplier cash flow was suddenly disrupted.
3. When does my early payment come?
Most supply chain finance programmes only offer early payments to suppliers AFTER delivery to the buyer’s premises. This is because the buyer will not usually approve the invoice for payment until the goods have been checked. In this situation, the supplier has a limited path to recovery if the early payment fails – and will have already handed over the goods before finding out if an early payment is available.
In comparison to trade credit, the early payment facility provided in most supply chain finance programmes does not provide the kind of protection to suppliers that are available in supply chain trade credit arrangements; as with trade credit, payment to the supplier is made against documents and before goods are delivered. In this situation, if early payment is not made, the supplier does not hand over the goods and has a path to recovery.
Point to check: Am I comfortable delivering my goods knowing that a confirmation of early payment will only appear later?
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Comments: When suppliers and buyers are in the same country, these issues over payment timing do not matter so much. Transit times for goods are short, early payment approval comes quickly. But when suppliers and buyers are distant (e.g. Asia to Europe), then payment timing can be crucial.
In the best programmes, the supplier early payment is made before delivery – for example, supply chain trade finance. This means that, if something goes wrong with the funder or the buyer, the supplier still has control over the goods and has a path to recovery. It also means that the decision to rely upon early payment by the supplier is made with a choice as to whether to deliver the goods or not.
Are these three questions reasonable?
One way to consider these three questions is to compare, (i) a long-dated invoice supported by an early payment option via supply chain finance with, (ii) a short-dated invoice. In the latter situation, the supplier has the ability to start pressuring for payment quickly and, if the supply is regular and repeating, to hold back further supplies if payment is not forthcoming. This is not easily the case when supply chain finance is involved – because the invoices are issued with long dates and an early payment arrangement is an option, not a commitment. And this means that the amount of unsecured credit provided to the buyer by the supplier in insolvency can be significantly greater than the supplier intended.
And the question of payment timing is very important for international supply chains. Supply chain finance is rarely a substitute for a proper trade credit arrangement where a supplier would normally request payment to be made against documents and before delivery.
How should buyers arranging supply chain finance move forward?
Supply chain finance programmes are a seductive and simple proposition for the buyer. But it is important to consider the programme from the supplier’s perspective.
Well-designed programmes that score best for ESG considerations:
- will facilitate early payment to suppliers before delivery so that the longer payment terms are counter-balanced by the availability of early payment to the supplier before goods are handed over;
- these programmes will be arranged using stable funding sources which can be easily replaced with alternatives if the funder fails; and
- will treat all suppliers equally, but this also means that the size of the supply chain finance programme must be appropriate to the scale of the supply chains involved.
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