Myths and Facts about Supply Chain Financing

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.

Why Supply Chain Finance is gaining traction globally

Supply Chain Finance (SCF) also known as supplier finance or reverse factoring is a set of solutions that optimizes cashflow by allowing businesses to lengthen payment terms to their suppliers while providing an option for the supplier to get paid early. It is instructive that typically, buyers wish to extend payment terms as far as possible, while suppliers woud prefer cash on delivery. Supply Chain Finance therefore provides a win-win situation for these conflicting objectives. The buyer optimizes working capital while the supplier generates additional operating cashflow thereby minimizing risks across the entire supply chain.

Whereas trade in Mesopotamia around 3,000 B.C used some basic forms of supplier finance (see Infographic), the documented history of SCF in its current form is traced to U.S.A. around 1980 as an offering by large US Banks. Early adopters were were retailers, followed by automotive parts distributors. The uptake was however heightened following the 2008 financial crisis as it helped buyers with strong ratings to protect their supply chains (both locally and internationally). SCF has since grown into a maintream trade finance product offered by global banks, regional banks and independent fintechs.

The potential market for SCF for OECD Countries is significant and estimated at USD 1.3 Trillion in annual traded volumes. This is considered far from capacity with experts estimating that only 10% of the global available marketplace has been satisfied with SCF solutions. The market is expected to continue to grow at approximately 20-30% annually.

The driving forces behind the growth of SCF programs are varied and include, but are not limited to:

  • Increasing risks in Supply Chains arising from globalization. This has significant impact on financials of large corporates.
  • Working capital has risen to the top of the agenda for CFOs and treasurers.
  • There is a strong interest from suppliers who require lower financing and predictable liquidity for planning purposes.
  • Open account trade terms now account for over 85% of global businesses (vs 15% documentary credits). This trend – which is unrelenting – has opened up opportunities for both exporters and importes to use cheaper working capital options of which SCF is the natural alternative.
  • Governments globally – e.g. UK, US, France, Netherlands, etc – have intervened in supply chains through legal legislations aimed at protecting SME suppliers. This legal force has created opportunities for SCF providers to facilitate early payment for suppliers.
  • Perhaps a key significant factor has been the emergence of fintechs that are using the power of data and automation to seamlessly link buyers, suppliers and funders thereby eliminating information assymetry between the parties. This has significantly reduced the risk to the funder while creating convinience to the buyers and suppliers.

 

 

 

 

Finally a unified definition for Supply Chain Finance?

 

Like most young concepts, Supply Chain Finance has not had a universally-accepted definition thereby creating inconsistency across the range of solutions available in the market. However in 2014, the International Chamber of Commerce championed the formation of an initiative dabbed the Global SCF Forum which brought together various industry associations with membership across the globe namely The International Chamber of Commerce (ICC) Banking Commission , BAFT (Bankers Association for Finance and Trade), the Euro Banking Association (EBA), Factors Chain International (FCI), and the International Trade and Forfaiting Association (ITFA).

During the launch of the Global SCF Forum in Dubai, Kah Chye Tan, Chair of the ICC Banking Commission said: “SCF is a growing market with considerable business opportunities identified for the near future. Given increased collaboration among the wide range of bank and non-bank representatives facilitating domestic and cross border trade, and the advent of Internet and new communication technologies, it is more important than ever before for all market participants to adopt universally-accepted terminology that corresponds to the rich array of processing, financing and risk management techniques currently being developed by the industry to support increasingly globalized supply chains

 

The Global SCF Forum, through a collaborative, inclusive and consensus-based process published The “Standard Definitions for Techniques of Supply Chain Finance” which builds upon hitherto excellent work by various professionals and institutions towards developing the lexicon for this fast-growing, high-value but still fairly nascent form of financing, which applies equally in support of domestic and international supply chains. It is hoped that this will introduce a consistent and common understanding as well as provide a useful reference point for the industry.

The Global SCF Forum has defined SCF as ….. “the use of financing and risk mitigation practices and techniques to optimise the management of the working capital and liquidity invested in supply chain processes and transactions. SCF is typically applied to open account trade and is triggered by supply chain events. Visibility of underlying trade flows by the finance provider(s) is a necessary component of such financing arrangements which can be enabled by a technology platform”.

This definition is further elucidated by dividing SCF techniques into two categories i.e. a receivables-based category and a loan/advance-based category. The former includes receivables discounting, forfaiting, factoring, and payables finance while the latter includes distributor finance, loan/advance against receivables, loan/advance against inventory, and pre-shipment finance in general.

Despite this wide definition, however, SCF is generically used to refer to the receivables finance technique variously referred to as payables finance, Reverse Factoring, supplier finance, confirmed payables finance, etc. This is a buyer-led program within which sellers/suppliers in the buyer’s supply chain are able to access finance by means of a true sale of their receivables to a participating funding party. The technique provides a seller/supplier of goods or services with the option of receiving the discounted value of receivables (represented by outstanding invoices) prior to their actual due date and typically at a financing cost aligned with the credit risk of the buyer. The payable continues to be due by the buyer to the funding party until its due date.

 

ECap’s current SCF offering is based on this approved-payables structure. However, we are increasingly innovating with a view to creating a working capital marketplace in the form of a one-stop shop where enterprises can fulfill their working capital needs using the various SCF techniques.
Want to learn more about our solutions, please contact us

Manufacturing & industrial winner: ARCELORMITTAL SOUTH AFRICA

arcelormittal-sa-e1480665439460

Category: Manufacturing and industrial

Winner: ArcelorMittal South Africa

Summing up: A supply chain finance programme with an enthusiastic rate of take-up was implemented with 12 weeks, injecting hundreds of millions of rand into the economy-afflicted South African steel industry.

What the judges said: “This programme was important for the local market. The onboarding process is carefully tracked to achieve a 48-hour onboarding target.”

Key facts:

  • One of the largest supply chain finance programmes in southern Africa
  • The programme was successfully implemented with a go-live within 12 weeks
  • Full liquidity capacity of ZAR1bn was achieved within eight months
  • The programme has freed up some ZAR1.25bn of cash for more than 50 suppliers – mostly SMEs – that are now on the platform
  • The multi-bank facility means suppliers can take advantage of highly-competitive rates

The entry:

The steel industry in South Africa has experienced one of the most challenging periods in its history, affecting hundreds of suppliers. ArcelorMittal, a major in the sector, recognised the challenges and  showed leadership by implementing a very successful supply chain finance programme which has provided a much-needed injection of finance into the South African steel industry.

ArcelorMittal South Africa negotiated increased payment terms with suppliers, typically from 30 days to 60 days, as well as streamlining its payment runs, providing a cash flow benefit to the group of almost ZAR600m.

However, the introduction of a supply chain finance programme enabled suppliers to secure early payment at competitive rates taking advantage of ArcelorMittal’s creditworthiness. Such was the rate of take-up that the ZAR1bn credit facility on offer from Barclays was fully-utilised within eight months. Many of the suppliers opted for auto trade to maximise the benefit.

The Propell Supply Chain Finance platform, in partnership with PrimeRevenue, has seen 97% of supplier invoices traded, proving that suppliers recognise the value in freeing up cash using supply chain finance. The onboarding process is as quick as 48 hours. More than ZAR1.25bn has been made available to suppliers, many of them SMEs that are not otherwise able to get cash at such competitive rates.

Figures on this scale make the programme one of the largest in southern Africa – and a true win-win for suppliers and for ArcelorMittal SA.

“The requirements from the other funders are almost impossible to meet and the rate they charge is much higher than the supply chain finance rate,” said one supplier in a testimonial. Another supplier reported that the cost of using supply chain finance rather than traditional invoice discounting reduced their financing cost by 16% pa – equal to ZAR160,000 savings for every ZAR1,000,000 of monthly sales to ArcelorMittal.

 

Source: http://www.scfbriefing.com/manufacturing-industrial-winner-arcelormittal-south-africa/