Supply Chain Finance (SCF) is subjected to various myths. I wish to take this opportunity to clarify some of the myths and to provide facts to enable funders, buyers and suppliers optimize the solution.
Myth 1: Funding is Committed
This is not true. One of the key characteristics of SCF is that funding by the Financial Institution is actually uncommitted. This is due to accounting requirements – in order to avoid having the buyer’s accounts payable being reclassified as debt, the funding is transactional and not permanent. Having an uncommitted credit limits implies that the Financial Institution can reduce credit limits, increase their funding spreads, or in the worst case scenario withdraw from a SCF program. To mitigate the risk of abrupt credit withdrawals by funding partners, most corporates work with multiple funding partners to finance their supply chains using a multi-funder SCF platform like the one provided by Ennovative Capital.
Myth 2: The success for the buyer in generating cashflows depends on suppliers participating in the program.
This is not true. To achieve working capital reductions, a buer needs to optimize payment terms within the supply base irrespective of the suppliers participating in a SCF program. The role of SCF is offset the negative impact of term extension on suppliers. The supplier does not have to join the SCF program in order for payment terms to be optimized.
To optimize payment terms, the buyer should first benchmark terms within the supply base taking into account individual supplier characteristics such as industry, commodity class, geography, and the buyer-supplier relationship. Commercial considerations such as length of contract, sole or multi-sourced commodity, etc must also be included.
After omptimization opportunities have been identified, the buyer needs to determine the supplier approach and messaging. Messaging needs to take into account the supplier’s business chacteristics including their corporate objectives, business drivers, economic impact of any term extensions and the supplier’s value of capital.
Next the buyer must prioritize suppliers, identify quick wins, dtermine KPIs and pull it all together into a strategy to achieve meaningful and continuous working capital efficiency improvements.
Finally, the procurement tean must be trained and provided with support throughout their supplier negotiations. Tools should be provided to the procurement team to monitor progress against objectives, ensure strategy compliance and incorporate actual results into program deployment.
Ennovative Capital has a working capital analysis too that provides the following:
- Clients can upload his spend data
- Identifies payment term opportunities and calculates the cashflow gain potential
- Results and KPIs are measured
- Targets and strategy can be readjusted
- Working capital can be unlocked in record time.
Myth 3: Rate arbitrage is a key decision factor for suppliers
There is a misconception that a low discount rate deducted from the invoice is the main factor attracting suppliers to make use of such a financing facility.
Research with buyers having a SCF program in place confirm that it is not necessarily the case. The main factor for a supplier is his materiality of sales towards the buyer.
Long payment terms are the 2nd most important reason why suppliers trade their receivables. If the difference between the existing payment terms and the proposed early terms is not substantial enough, suppliers will see no benefits to join a SCF program.
Another key factor is the value of cash and on-demand liquidity versus cost of capital. Suppliers with a high value of cash are more likely to choose early payment terms to control cashflow without incurring debt.
The discount rate (or rate arbitrage) is considered only a minor factor. For instance, a supplier having financing costs of 3% p.a. Would find a discount rate of 2.0% p.a reasonable.
Myth 4: A Funder-independent Fintech adds cost to a SCF Program
This is not true. On the contrary using the expertise and solutions from the Fintech has proven to reduce the overall cost of SCF programs and improve results.
A funder-agnostic platform is in a much better position to ensure efficient liquidity pricing over the life of the SCF program through the ability to bring in multiple funders to ensure price competition.
The buyer has a great deal of leverage to influence pricing and other aspects affecting its supply chain efficiency. The platform provider must provide add-on services including continuous working capital analysis, program design services, customizing supplier messaging, procurement training and tools, education and enablement of suppliers, etc.