Payment terms are often a source of extensive negotiation between suppliers and buyers because they have a major impact on the financials of both companies. Longer payment terms work in the buyer’s favor but can make cash flow management more challenging for the supplier. The reverse is true with shorter terms.
Supply chain finance can resolve this challenge by using a financial intermediary to increase cash on-hand for both those selling a product or service and those purchasing them. This can make it an appealing option for companies that often have many suppliers to manage and pay across the globe.
What Is Supply Chain Finance (SCF)?
Supply chain finance is an agreement in which the buyer partners with a financial institution that will then pay suppliers on the buyer’s behalf. These suppliers may have to sign up for the program, but the onus of setting it up is on the purchasing company. After the business buys something from the supplier, the seller can request an early payment and the financier — often a bank — will quickly pay them less a small fee. The purchasing company then pays the funder at a certain agreed-upon date in the future.
The central benefit of supply chain finance, also called reverse factoring, is that suppliers can be paid in a matter of days and buyers may get longer terms than those provided by the supplier. This can strengthen the financial position of both parties by increasing cash flow and working capital. Companies may use this option only as necessary, like during the slow season if they experience seasonal spikes and dips in demand.
Key Takeaways
1. Supply chain finance is a buyer-led type of financing where the buyer works with a third-party financial institution that will pay suppliers quickly while providing the purchaser extended terms.
2. Under this agreement, suppliers can often be paid in a few days while their customers don’t have to pay their invoices for several months.
3. This technique can boost working capital for both parties while also supporting the long-term viability of suppliers. That means it can strengthen the customer’s supply chain.
4. While this financing method lost popularity for some time, it’s having a resurgence as businesses seek cheaper sources of capital due to inflation and climbing interest rates.
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