Supply Chain Finance – Tool for Working capital optimisation

Supply Chain Finance (SCF) is a method to provide short-term working finance to dealers/ suppliers who have business relations with large corporates. In this type of financing, technology is used to finance the dealers and suppliers based on the invoice uploaded on the digital platform.

Generally, in any business transactions, the supplier would like to be paid immediately for the goods supplied whereas the buyer would want to extend credit period for the goods purchased.

SCF bridges the gap between the buyer & the supplier and aids in improving the cash conversion cycle for both the parties.

Types of Supply Chain Finance:

Dealer finance:  In this type of finance, the bank provides working capital limit like overdraft to the dealers (i.e. buyers of the manufacturers). Each disbursement is made against the invoice raised by manufacturers on dealer. It will have fixed tenure of repayment date for each invoice. Disbursement out of the overdraft account will be made directly to the manufacturer’s account against the invoice raised for the goods sold to the dealer. The invoice should by duly accepted by the dealer.

ILLUSTRATION: 1

ABC motor is authorised dealer of Maruti and procures car of different variants from Maruti. ABC motor requires credit period of 90 days to make payment to Maruti. On the other hand, Maruti requires immediate payment. In this scenario, Dealer finance facility can be given by the bank.

Overdraft account will be opened in the name of ABC motor, disbursement from the Overdraft account will be made against each invoice raised by Maruti and duly accepted by ABC motor and the amount will be directly credited to the account of Maruti. The Outstanding balance in overdraft account will be adjusted out of sales proceed of the car.


Vendor Finance
: In this types of finance, bank provide overdraft limit to the vendor i.e supplier of manufacturer.  The disbursement in the overdraft account of the vendor will be made against each bill raised by the vendor on the manufacturer and duly accepted by the manufacture and amount will be credited in the designated account of the vendor.

ILLUSTRATION: 2

Happy spare parts is supplier of ancillary parts to Maruti. As per business policy of Maruti, payment to supplier is made after 80-90 days from the date of supply. Happy spare parts wants immediate payment but it do not want to lose the opportunity to deal with Maruti.  In this scenario Vendor, finance facility can be given to Happy spare parts.

Disbursement will be made in the overdraft account for each bill raised by Happy spare parts on Maruti and the amount will be credited in the designated account of Happy spare parts.


Payable Finance:
 overdraft facility will be provided to the manufacturer. Each disbursement will be made in the account against the invoice raised by supplier / vendor on manufacturer and the amount will be credited vendor/ supplier’s account.

ILLUSTRATION: 3

In the illustration 2, given above.  If credit facility is extended by the bank to Maruti instead of Happy spare parts then it will be known as Payable finance.  Disbursement from overdraft account of Maruti will be credited to Happy spare parts account.

Advantage of Supply Chain Finance over Traditional Finance:

  • SCF is given to high quality customers, who recommend their vendors/ suppliers and dealers thereby enhances quality of credit at each level. Whereas in Traditional finance, credit is given to customers based on their individual assessment that is more risky.
  • Financing/ disbursement is done only when there is underlying valid invoice/ trade transaction between the parties. Disbursement is directly credited to the account of vendor, manufacturer, or dealer as the case may be. Thus, the product ensures better control on the transactions vis-vis traditional limit like cash credit.
  • Due to lower risk and better monitoring mechanism, the rate of interest for his product is lower than that of traditional finance, thereby benefitting the borrowers.
  • The process cannot be tampered easily, hence reduces the chance of fraud.

Benefits of Supply Chain Finance:
Dealer:

  • Finance available at lower rate of interest
  • Steady and economical source of working capital
  • Since it is cash flow based lending – scope of under finance or over finance will be less
  • No need of collateral security.
  • Smooth operation of business with continues replenishment of stock.

Manufacturer

  • Can easily convert receivables into cash  which in turn improves liquidity
  • Improves financial ratios.
  • Improves business efficiency
  • Increases profitability

Vendor

  • Easy & convenient source of working capital
  • Cheaper source of finance
  • Increase in business efficiency & profitability
  • Irrespective of limited resource can create business relationships with large corporates.

Transactional Process flow

Dealer Finance:

  • Manufacturer initiates the transaction by uploading digitally signed invoice in the digital platform.
  • At the backend, pre validation check of the invoice is done i.e. value of invoice, limit availability etc.
  • Once the invoice is validated, the disbursement is initiated at the back end and amount is transferred by debiting Dealer’s overdraft account and crediting manufacturer’s account.

Vendor Finance

  • Manufacturer initiates the transaction by uploading digitally signed invoice in the digital platform.
  • At the backend, pre validation check of the invoice is done i.e. value of invoice, limit availability etc.
  • Once the invoice is validated, the disbursement is initiated at the back end and amount is transferred by debiting  vendor’s overdraft account and crediting vendor’s designated account

Payable Finance:

  • Manufacturer initiates the transaction by uploading digitally signed invoice in the digital platform.
  • At the backend, pre validation check of the invoice is done i.e. value of invoice, limit availability etc.
  • Once the  invoice is validated, the disbursement is initiated at the back end and amount is transferred by debiting manufacturer’s  overdraft account and crediting vendor’s designated account

Growing importance of supply chain finance in India:

Supply chain finance is an attractive opportunity to all the parties like buyer, supplier, and finance providers. Buyers and suppliers get working capital assistance and flexible cash management opportunity, while banks gain revenue by lending for short term.

It is more suitable for small suppliers / MSMEs who do not have the requisite skills to maintain proper financial data, who lack the ability to offer collateral security. These small business centres lack access to formal credit due to their inherent limitations. Supply chain finance is a boon for such entrepreneurs.

The growing revolution of fintech is also aiding in popularity of supply chain finance. With the help of technology is block chain, it allows significantly increased settlement at a lower cost as the shared ledger services will help all the related parties to update their part of transactions and also  verify the authenticity and provenance of all the data available in the shared ledger.

Supply Chain Finance offers a “Win-Win scenario” for all. If implemented properly, the entire supply chain – buyers, suppliers, and financial intermediaries will stand to benefit from SCF. Apart from working capital optimisation, it also improves the buyer- supplier relationship.

(Views expressed above are the personal opinion of R Sumitra, Faculty credit, Bank of Baroda)

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