COVID-19 has affected every aspect of business, including supply chains. During this uncertain time, supply chain finance can help businesses that are struggling to make their payments.
Far-flung global supply chains with smaller and midsize suppliers have been particularly affected by COVID-19, said Matt Lekstutis, global practice leader of supply chain at Tata Consultancy Services, a consultancy based in Mumbai, India. Many of these companies, still reeling from the effects of the Great Recession, have experienced a dramatic disruption in cash flow. Payments became uncertain as products and materials stood idle in shipping containers or warehouses.
"Supply chain finance can bring stability and flexibility to these supply chains by bringing the lowest cost of capital to where it is needed most in the supply chain to shift focus from survival to improving efficiency, innovation and investment in new products," he said.
Supply chain finance gives buyers and suppliers more flexibility with their payments.
Buyers and suppliers need liquidity in the supply chain, particularly now, said Sebastiaan Wissink, a consultant at the Netherlands consulting firm Capital Chains.
"The buyers want to be sure that they can always pay their suppliers on time or even [in] 30 payments," Wissink said. "With a supply chain finance solution, you can [even] pay your supplier earlier than the regular payment [and] be more certain that your supplier will deliver the goods to you."
What is supply chain finance?
Supply chain finance aims to lower costs for both buyer and seller. It typically requires a cloud-based platform to which the buyer and supplier both have access.
At its core, supply chain finance is reverse factoring, said Miguel Cossio, research director at Gartner. A buying organization uses a third-party funder to extend its payment terms but pays its suppliers earlier.
The third-party funder is usually a bank or investing company. It pays the buyer's suppliers early, giving them that liquidity. The buyer then pays that third party according to the buyer's payment terms, preserving the buyer's cash for longer than usual.
This is one of the very few initiatives that is truly win-win between buyers and suppliers.
Miguel CossioResearch director, Gartner
"Usually [in situations where supply chain finance isn't being used], the flow is that the suppliers ship you the goods, they invoice you, you receive the invoice and the payment terms start running," Cossio said. "The buying organization issues the payments upon expiration -- 30 days, [for example]."
In that system, there isn't any wiggle room with payments.
With supply chain finance, however, the buyer can set up a program to pay its suppliers with flexible programs, said George Lawrie, an analyst at Forrester Research. Supply chain finance is reverse factoring because it's the buyer that is financing the order rather than the supplier trying to finance it.
Supply chain finance is meant to be a positive for all sides of the equation.
"This is one of the very few initiatives that is truly win-win between buyers and suppliers, meaning buyers want to increase their payment terms and they can do that using supply chain finance," Cossio said. "And suppliers want to get paid earlier, and they can do that with supply chain finance."
How supply chain finance programs work
With supply chain finance, buyers and suppliers use the cloud-based platform to communicate about their finances and work with their financial institution. There are a number of financial technology platforms that aim to simplify supply chain finance.
According to Mark Peicker, senior director in The Hackett Group's finance transformation practice, this is how the buyer and supplier would use the program:
The buyer sets up the system and onboards the supplier.
The supplier uploads its invoices to the buyer via the supply chain finance system.
The buyer approves the supplier's invoices.
The supplier views the approved invoices and decides which invoices it wants the buyer to pay early.
The buyer notifies its financial institution that those invoices need to be paid. The buyer then pays back the financial institution according to the buyer's payment terms.
Supply chain finance helps suppliers and buyers in multiple ways. Here are four benefits of the system.
In addition, they're able to do so without hurting their suppliers' cash flow, Cossio said.
"You're also helping the suppliers, especially during these times, and everybody is concerned about the financial health of their suppliers, especially the small and medium suppliers that are the ones who are most at risk of going bankrupt," he said.
2. Suppliers can control their cash flow
With supply chain finance, suppliers have more choices about how they get paid.
For example, suppliers can schedule when that will happen, Cossio said.
"Maybe they say, 'I want to get paid in 15 days,' and they can schedule that once a month," he said. "Usually, most of these solution providers give the suppliers the view of the cash flows, what they can expect and when, so they're better able to manage their cash flow, which is a huge deal for them. And, since suppliers are getting paid faster, they can invest that in growing the business."
3. Suppliers have access to lower interest rates
With supply chain finance, suppliers can get lower interest rates than they would otherwise.
For instance, a supplier like a small genetic pharmaceutical startup may not normally qualify for the lowest interest rates, Lawrie said. Suppliers like supply chain finance because the buyer is typically a larger company with a better credit rating. The buyer can do financing more easily than the supplier.
In addition, the supplier doesn't have to use its own funds during the financing process.
Because supply chain finance is set up by buyers and it's financed through them, suppliers don't have to finance with their own working capital, said Josh Nelson, associate principal in The Hackett Group's supply chain strategy and transformation practice.
4. The buyer-supplier relationship is strengthened
With supply chain finance, the buyer and the supplier are invested in the success of the other.
"Some of the larger organizations I've dealt with have these strategic relations with small suppliers, and they can't lose them because, if those suppliers go out of business, then the buyers lose a critical piece of the products they're producing," Peicker said.
Because of that, buyers might work with their suppliers to ensure the quality of the products they need and possibly do some of the design work, he said.
Meanwhile, supply chain finance gives buyers a means to help their suppliers.
"If buyers want to keep those small pharmaceutical companies or small apparel or footwear companies working for them, then they want to do everything that they can to help them," Lawrie said. "And, if that means helping their working capital, making sure they don't go out of business, well, that's to the [buyers'] advantage in the long term."
COVID-19 obstacles to supply chain finance
Despite these benefits, COVID-19 has created some challenges for supply chain finance.
One of the biggest obstacles on the buyer side is that many are working remotely during the pandemic, making it more difficult to implement the technology, Wissink said.
"When you decide to implement a supply chain finance solution, you need to align all the departments involved," he said. "And that's really hard right now when everybody's working from home."
A supply chain finance implementation is always perceived as a big change, and people need to collaborate to make it work, Wissink said.
The teamwork that would be needed for putting that technology in place just may not be possible right now.
In addition, companies have implemented aggressive cash preservation strategies to manage the financial risk caused by dramatic shocks to the economy and uncertainty about the path to recovery, Lekstutis said. They may be reluctant to change supply chain finance processes or capabilities.
Because of recent disruptions, companies are fundamentally rethinking their supply chain structure to drive increased resiliency and lower risk, Lekstutis said.
"And, as companies move through these strategic reevaluations of their supply chain structures, they may be reluctant to embark on supply chain finance until they settle in on the structure they want to take forward and invest in," he said.
