Most entrepreneurs nowadays explore prefer meeting working capital needs and manage liquidity though modern alternatives to conventional small business loans. As an alternative to conventional small business loans, supply chain finance enables business owners to avail short-term credit by linking the buyers, seller and lending institutions. The financial solution allows a supplier to avail short-term credit by selling their unpaid invoices or account receivables to a lending institution at a discount.
However, the buyer must approve the supplier’s invoice and agree to make payment to the lending institution on a particular date. Hence, supply chain finance or reverse factoring helps small business owners to meet immediate financial needs by selling the unpaid invoices to lending institutions at a predetermined discount rate. At the same time, the financial solution helps buyers to purchase products from the supplier at lower prices or better payment terms.
Understanding Important Aspects of Supply Chain Finance
Alternative to Conventional Term Loans
Many business owners look for alternative to term loans to repay the debt in a flexible and convenient way. Unlike term loans, supply chain finance enables entrepreneurs to avail short-term credit without paying equated monthly instalments (EMIs). A supplier can opt for this option to meet working capital needs by selling his outstanding invoices to a lending institution.
The lending institution will further receive payment from the buyer of the goods on a due date. Hence, supply chain finance can be beneficial for both buyers and suppliers. A supplier can meet his immediate financial needs by selling the unpaid invoices to a lending institution. Likewise, the buyer can also take advantage of supply chain finance to negotiate with the buyer for favourable pricing or extended payment terms.
Different from Invoice Discounting and Factoring
Like factoring and invoice discounting, supply chain finance also enable suppliers to avail short-term credit against unpaid invoices or account receivables. But factoring required the business owners to sell invoices or account receivables to a third-party financial institution acting as a factor. Likewise, invoice discounting enables a business owner to avail credit by using his unpaid invoices as collateral. Interested readers can read more on factoring vs bill discounting.
Supply chain finance is designed exclusively as a form of working capital finance. The supplier has to sell the invoices to the lending institution based on the consent and approval of the buyer. The lending institution will recover the money from the borrower. The supplier is not obliges to step in if the buyer does not pay the lending institution.
Involves Both Supplier and Buyer of Goods
A supply chain financial transaction involves three parties – supplier, buyer and lending institution. The supplier of goods avails credit by selling the unpaid invoices to a lending institution at a predetermined interest rate. However, the buyer of the goods must approve the transactions. The buyer of goods must agree to make payment to lender on a particular date. Hence, the financial institution purchases unpaid invoices from the supplier at a discounted rate and receive payment for the invoice from the buyer on a particular date.
Can be initiated by both Buyers and Suppliers
Supply chain finance can be broadly divided into two distinct categories – buyer-initiated programs and supplier-initiated programs. If the financial transaction is initiated by the supplier, the supplier is required to sell the unpaid invoices to the lending institution after getting the buyer’s approval. The financial institution will purchase the invoices from the supplier before their due date.
Also, it will receive payment from the buyer when the invoice is due. On the other hand, if the buyers initiate the supply chain finance program, they either introduce the supplier to the lending institution or instructs the lending institution to make payment to the supplier before the invoice is due. In such cases, the buyer repays the invoice to the lending institution with the required fees or interest.
Takes Advantage of Financial Technologies
Most lending institutions nowadays use the latest financial technology (fintech) to simplify supply chain finance. They create a web-based financial platform to track financial transactions, track invoice approval process, and initiate invoice settlement processes. The online platforms further make it easier for both buyers and suppliers to initiate supply chain finance. The financial technologies even contribute hugely towards making supply chain finance a viable alternative to conventional term loans in a short amount of time.
On the whole, supply chain finance is a modern financial solution that helps entrepreneurs to meet short-term financial needs by selling unpaid invoices or account receivables to a lending institution at a predefined interest rate. But the financial solution requires the approval of both supplier and buyer of goods. Also, the buyers and suppliers must agree to the terms set by the lender to take advantage of supply chain finance.