Supply Chain Finance (SCF) is a cash flow solution that optimizes the management of the working capital and liquidity. Encompassing financial opportunities, it is a technology-based solution that aims to lower financing costs and improve business efficiency for both buyers and suppliers.
Originally, provided by banks to bridge payment gaps for buyers’ large and strategic suppliers, SCF is becoming an increasingly adopted technique across all industries. From emerging methodologies to automate transactions and tracking invoice processes, SCF offers distinct end-to-end advantages. To simplify this, let us understand the three commonly known biproducts of supply chain finance.
• Vendor Finance: Most suppliers to large corporates are mid and small-sized businesses usually in dearth of organized credit limits either due to poor credit rating or lack of security. Under Vendor Financing, these suppliers not just avail credit at a better interest rate but also on an unsecured basis as banks draw their comfort on the underlying trade in the form of an accepted invoice with the buyer and its credit rating.
• Buyer/Channel Finance: Large corporates face higher Days Sales Outstanding (DSO) with buyers, distributors, or retailers due to informal credit and uncertainty of payment receipts. Buyers at times lack purchasing power which impacts corporate sales. Lenders under this product finance buy through a dedicated procurement credit line for their associated corporates creating better interdependency and repayment behaviour.
• Factoring: It is a form of Receivables Purchase wherein sellers of goods and services sell their receivables (represented by outstanding invoices) at a discount to the finance provider (commonly known as the ‘factor’). Factoring usually offered by specialized finance providers is operated as a factor. It explicitly targets the receivables financing market and serves a wide array of supplier companies as small and medium-sized enterprises (SMEs). Factoring is also extended to large value transactions and may also offer Receivables Discounting services on the back of Credit Insurance.
Improvement in recovery numbers and a steep drop in casualties is setting the course towards normalcy. While businesses are getting back to their usual cycles, MSME’s collection woes remain. MSME Samadhaan (Delayed Payment Monitoring System) launched and managed by Govt. (in Oct 2017) presently shows less than 10% resolution on cases filed. Over 1.05 Lac applications have been filed by MSMEs facing payment issues where 22561 cases have been rejected and 27944 cases are under consideration. These numbers are striking enough and speak about the real problem. The fact is that small businesses have always been suffering from a working capital crunch even before the pandemic. Customarily retailers, distributors, and suppliers have been cash-strapped for a long time now and are left with no option but to compromise in the face of convenient access to the capital. They are forced to liquidate savings or resort to unorganized sources of cash or high interest-bearing gold loans.
Supply Chain Finance acts as a boon by bridging the working capital shortfall for distributors and vendors that have longer payment cycles. All stakeholders under any transaction either payable or receivable are eased with early payments which in turn refreshes their procurement, enables higher sales cost-effectively.
Lenders under SCF benefit from factors including shorter working capital cycle, cash flow predictability, and control on inventory through end use finance. Additionally, repayment tenors under Channel Finance programs may vary from sector to sector. Consumer durable, technology, and FMCG industry may have a shorter range of 30-45 days, while it can be 90- 120 days for textile, chemical, and infrastructure.
The infrastructure and construction material businesses are yet to taste the convenience that SCF can bring to the ecosystem. The preconceived notion for the sector, being risky has slowly changed over the years with RERA coming into action along increased usage of new age equipment that has reduced the overall construction time. SCF techniques such as Factoring can enormously help both corporates (supplier and buyer) in their transaction with a certainty of payments with mutual risk participation. Similarly, cement and Ready-Mix Concrete (RMC) suppliers can make significant use of Vendor Finance programs to encash early payments on the back of being associated with established buyers.
Digitization in Supply Chain Finance
Digitization is the present and the path to the future. With the help of tech innovation and open data avenues, we are witnessing a ‘never seen before’ pace at which FinTech is democratizing SCF. Lenders are now comfortable financing, not just distributors of a large corporate but even retailers in the same chain, relatively smaller ones as tier two lending.
Furthermore, new-age lenders have gone ahead and extended their balance sheet for credit limits as low as Rs. 20,000 to 50,000 with per transaction and value as low as Rs. 1500 to 2000. All this and much more is possible only with the advent of digitized supply chain finance. Besides, in the case of large corporates, SCF integrates with Enterprise Resource Planning (ERP) giving a plug and play configuration to get their invoices discounted through a lender supporting this transaction in the back end. Offering customized solutions at the convenience of a click, these platforms enable the generation of data intelligence and fund utilization trends for future.
Distributors & suppliers financed through these platforms finally help manufacturers and lenders make informed decisions in terms of credit limit sanctioning and disbursement. By using digital documents, automating validations, and algorithmic risk evaluation, both the cost and time are reduced drastically.
Blockchain in Supply Chain Finance
A comprehensive approach to SCF requires all parties in a transaction to share a common digital infrastructure. Blockchain is a digital ledger that can be shared, is non-deniable, immutable, and enables smart contracts. E-invoicing could be a good example tested over blockchain as this would create a record from issuance to acceptance in addition to assuring the lender from non-duplication, acceptance, and digital GRN. These features across blockchain will reduce the cost of supply chain finance and certainly increase its reach – and all this will happen sooner than you think.
Given the complexity of the trade finance market, supply chain finance provides an opportunity to collaborate and create benefits for stakeholders on both sides of the transaction.
By Pavan Matai, Head – FinTech & Supply Chain Finance, Infra.Market