Supply Chain Finance constitutes an arrangement between a buyer, a supplier, and a financial intermediary where the credit standing of the buyer is leveraged to improve the working capital position of a supplier. Typically, such arrangements involve a large, financially strong company that is supplied by several SMEs and innovative start-ups, and a financial intermediary – often a bank.
SMEs and start-ups send their invoices to the buyer, which authorizes the financial intermediary to pay the invoice on behalf of the buyer, often within fifteen days. The financial intermediary credits the buyer for the invoice amount, and the buyer reimburses the bank after an agreed period that often exceeds sixty days. In this manner, Supply Chain Finance allows buyers in a supply chain to postpone the payment of invoices, while suppliers see their invoices paid rather swiftly.
This is a solution to the widespread problem that many SMEs and innovative start-ups face when dealing with large buyers, as these large companies often pay their invoices only after a significant amount of time. This introduces a major liquidity risk to SMEs and start-ups that often feel financially squeezed by this practice. Swift payment of invoices improves the operational liquidity of suppliers, which increases their economic potential and can benefit their economic performance, and can positively influence the overall economy.
Similarly, late payment of invoices by the buyers improves the buyers’ liquidity, which improves their working-capital ratio. In general, buyers engage in Supply Chain Finance for one of three reasons:
1. To improve their working-capital position by extending their Days Payable Outstanding (DPO);
2. To mitigate risks in their supply chain in relation to strategic suppliers;
3. As a tool in discount negotiations with suppliers.
Offering a low-risk profit to financial intermediaries, already several billions of Euros are channelled from buyers to suppliers via Supply Chain Finance arrangements each year. As it is applicable to any sector that involves large companies being supplied by smaller ones, the market potential for Supply Chain Finance is considered to be quite large.
A growth-rate of up to 40% per annum is predicted for the coming years, stabilizing to 10% growth in 2020.
Supply Chain Finance is driven by financial pressure on both buyers and suppliers. Because of this, and because it is unusual to be presented with mutually beneficial innovations in buyer-supplier financial arrangements, the build up of trust and understanding between both parties is essential for a successful implementation of Supply Chain Finance in any supply chain. Also, tools such as e-invoicing need to be integrated in the financial processes of both parties, and especially on the side of the buyer, specific legal and accounting issues need to be resolved.
Typically, banks are selected as financial intermediaries for Supply Chain finance arrangements for their financial capacity, especially those that have operational experience in managing these arrangements.
However, as the volumes channelled through Supply Chain Finance arrangements grow, banks can request the involvement of additional investors to finance the arrangement.
Moreover, as these volumes increase, adding complexity to the financial structure of the arrangement and entrenching it deeper in the supply chain, a potential risk emerges concerning the feasibility of ending the arrangement when so desired.
European governments can play a role in the positive uptake of Supply Chain Finance in several ways. The use of e-invoicing could be encouraged throughout the economy, for instance by increasing the use of e-invoicing in public procurement.
EU directives related to payment terms could be reviewed to see if unintended legal complications for implementation of Supply Chain Finance can be resolved. The significance of potential risks associated with Supply Chain Finance could be investigated in a government commissioned study.
At a macro level, Supply Chain Finance is at least partially a response to challenges faced by SMEs and innovative start-ups concerning access to finance. Improving their overall access to finance de-prioritizes Supply Chain Finance as a tool to free up working capital.
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