Supply Chain Finance (SCF) refers to the set of solutions for financing specific goods as they move from origin to destination along the supply chain. SCF is one of the different methods used by companies to manage their working capital. In general, we can find three principal groups of solutions:
- Negotiation of payment conditions
- Financial institution services
- Collaborative solutions
Inside each group, there are several specific methods but this range of solutions tries to give an answer to one of the troublesome areas explained in one of our previous post, the financing of working capital. As the access to banking credit is tighter than ever before and financing costs are rising, companies have begun to look towards other alternatives where the Supply Chain is a key element. In fact, the problem of working capital financing is not unique to crisis periods, but during these tough times companies have focused more than ever on managing their working capital needs.
One of the results of this focus has been the emergence of SCF solutions, with the overall goal of optimizing the working capital along the whole of the value chain, making it stronger and providing an alternative source of liquidity to all its members.
The first solution to address the issue of working capital funding was negotiation among different parties, with methods, such as deferred payment strategies, where the only goal was to advance receivables and delay payments. Overall payment due date negotiation between businesses is a zero sum game. Nevertheless, due to power and strength differences, the negotiations resulted always in favor of one of them, which impaired the smaller members of the chain with unfavorable payment conditions.
As a result of these problems, the solutions of intermediation proposed by Financial Institutions emerged. Factoring and Reverse factoring are just some examples. Both partially solve the problem of bargaining strength but add high costs in terms of discounting fees and interest rates. Traditionally, these solutions have been used by small and medium size enterprises to try to solve the consequences of the payment conditions imposed by larger players but, nowadays even high-rated companies are making use of them.
Exhibit 1. Financial institution services: factoring description.
Nevertheless, these intermediation solutions create a huge dependency on the banking system. This has then turned into a significant area of concern for both Governments and large buyers, above all, among those belonging to sectors where the guaranteed smooth operation of the whole of the supply chain is essential, such as the food, automobile or chemical industries.
In this environment, highly characterized by the integration of the supply chains, collaborative solutions have started to grow in order to enhance the negotiation and collaboration between suppliers and buyers. Currently, only a small percentage of companies are using SCF techniques, but more than half have plans or are investigating options to improve supply chain finance techniques. Slow adoption of SCF programs does not depend on lack of demand from businesses but on the resistance of the Banking System to change the way it operates.
However, some banks are putting their factoring business under the wider Supply Chain Finance “umbrella”, trying to move from a traditional product-centric approach to a client-centric strategy but client-centricity is not about naming but about solving the customer problem. Banks reluctance to adapt their services to the new needs and offerings is causing the rise of solutions that promote the investment of available liquidity in one’s own supply chain, accelerating payments and cash collections, so that early payment discounts are seen as an asset allocation alternative with higher profitability and less risk than those offered by banks. This collaboration creates a win-win relationship for members of the chain, increasing their combined financial strength.
Given the complexities of modern financing and business to business payment techniques, invoicing including invoice automation and discount management initiatives need a framework to ensure that programs are approached on a strategic basis which bridges the supply chain, purchasing, accounts payable and finance organizations. These are some of the challenges that solution providers offering SCF and dynamic payables discounting solutions should face.
Exhibit 2. Early payment platform (example) description.
In addition to this, there are other alternatives that go one step further, leveraging not only the supply chain itself but also the network that each individual company creates from its own daily operations in order to find potential netting cycles that can compensate commercial debts.
Through this process, companies are able to minimize the number and volume of cash transactions, and hence, the banking fees associated with the same transactions. These solutions allow businesses to reduce their dependence on the traditional banking system alternatives and at the same time significantly improve their working capital and cash flow management. By applying these techniques, businesses achieve an important reduction in their funding needs and credit risk exposure.
LICUOS is one of the few companies capable of offering this degree of innovative and disruptive processing. Throughout its innovative patent pending technology solution, LICUOS enables an efficient and highly secure processing of accounts payable and receivable transactions, 24/7 and in real-time, to deliver the best possible financial optimization and user experience. Furthermore, LICUOS gives businesses full control and visibility into the payment process and allows them to easily communicate and negotiate with their business partners.
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