Supply Chain Finance: Definition & Meaning
Supply chain finance (SCF) is a subcategory of financing that facilitates the buying and selling of goods or services in the supply chain. It’s also known as asset-based lending or collateralized lending.
SCF provides an advance payment for businesses to make purchases of inventory, raw materials or other goods. It’s an effective supply-chain financing program to increase your cash position.
Rather than borrowing from a bank, businesses can use third-party sources for financing. This is as long as there’s an agreement to give them money only if they receive collateral in return. This article explains everything you need to know about SCF and its various financing options.
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- One of the biggest advantages of supply chain finance is that it allows companies to take advantage of market conditions.
- If a company uses SCF to buy goods that are already in the market, it can wait until the price of those goods drops before selling them.
- SCF companies may look at a company’s financials, but they are more concerned with the value of the inventory they are purchasing.
- Although SCF is a convenient way to get financing, it is important to make sure the inventory is valuable and will sell for enough money.
What Is Supply Chain Finance?
Supply chain finance is a process that provides companies with additional financing options. When a business wants to make a large purchase, it can finance it by borrowing money. This can be either directly from banks or through third-party financing sources.
SCF allows companies to take out a loan to purchase inventory or raw materials. Then, they use their inventory as collateral to repay the loan when it comes due.
The inventory is the security against the loan, so if a company fails to repay the loan, the lender can sell the inventory to recoup the money.
SCF is one of the fastest-growing areas of finance. In the last decade the market has exploded. What happens when a business doesn’t have a good credit rating or enough cash flow to qualify for a loan? Banks, financial institutions, and specialized companies are providing more financing options.
How Supply Chain Finance Works
Supply chain finance is conducted through an auction process. The process works as follows: A company that needs financing costs for purchases of inventory or other goods puts those items up for auction. Several lenders bid to buy that inventory.
The lenders then lend money to the company, based on the amount and value of the inventory itself. The company pays interest on the loan and repays the principal when the goods are sold.
Because the lenders are relying on the inventory as collateral, the company can borrow more than it would be able to get from banks. If the borrower fails to repay the loan, the lender can repossess the assets and sell them so that it is repaid in full.
Supply chain finance solutions are typically used when a company needs to make a large purchase but lack the cash flow to finance it.
It serves as a win-win situation in international trade. Current supply chain solutions can ensure short-term credit to allow for modern supply of sales activities.
Extended payment schedules help reduce the burden of payment. This allows the physical supply chain to proceed with its trading partners until the next payment period.
Benefits of Supply Chain Finance
Because the assets used as collateral in a supply chain finance arrangement are already owned by the company, there is no need to find a separate lender who is willing to take on those assets as collateral.
If a company were to use asset-backed security, like a car or machinery, as collateral, it would lose access to it while it is being used as collateral. Another advantage of supply chain finance is its speed.
And because the process is automated and conducted online, it is quicker to obtain financing compared to a bank loan. Just a single bank loan requires several steps and takes time to process.
Moreover, the payment terms might not benefit the borrower. With the supply chain finance process, companies can close their cash flow gap by getting cash in advance.
The injection of cash allows for benefits for suppliers, such as faster supplier onboarding.
Example of Supply Chain Finance
Let’s say that a clothing Supplier XYZ plans to launch a new line of sweaters. To have enough inventory for the holiday season, the company needs to order sweaters from a factory in China within the next few weeks.
The factory’s payment terms require it up front, which clothing Supplier XYZ can’t afford to do. Without the funds to pay for the sweaters, the Supplier XYZ is unable to launch the new line of clothing by the holiday season.
So clothing Supplier XYZ turns to a supply chain finance company seeking a loan to pay the Chinese factory so that it could launch the new line of sweaters on time. This ensures greater efficiency for buyers.
SCF Company ABC agrees to provide a loan to the clothing company, but takes possession of the sweaters as collateral. SCF Company ABC then sells the sweaters on the open market.
After the sweaters have been sold, SCF Company ABC pays the Chinese factory. Clothing Supplier XYZ repays SCF Company ABC.
Why Is Financial Management Important to Supply Chain Operations?
Cash flow management is the process of ensuring that a company has enough cash on hand to meet its short-term obligations. This includes paying for raw materials, paying employees, utilities, and other expenses.
It also includes having enough cash on hand to pay off outstanding debts. This can help prevent a liquidity crisis that could hinder a business’s growth. Financial forecasting involves creating a forecast of a company’s expenses and income based on current and future financial situations.
This is important because it allows a company to see what financial actions they need to take in the present to better their future financial condition. Financial forecasting can also assist in cash flow management.
Supply chain finance is a growing market that is changing the way companies do business. Large, established companies have been using SCF for years. But in recent years, smaller, younger companies have started using it as well.
While SCF has been around for years, it’s important for companies to understand the basics of how it works to see if it’s an option for their business. This can help with economic growth and it’s an effective financing method. Plus, it can lead to better relationships with suppliers throughout the entire supply chain.
Finance providers are always looking for new opportunities when it comes to the financing structure. Supply chain finance can provide better financing rates. This can lead to more affordable financing options.
FAQs About Supply Chain Finance
What Is the Difference Between Trade Finance and Supply Chain Finance?
Trade finance is the financing of goods being traded internationally. Supply chain finance is the financing that goes on behind the scenes in a company’s supply chain. It is the financing that helps businesses to buy the materials and stock that they need to get their products to market.
How Does Supply Chain Interact with Finance?
Businesses have to have cash on hand to meet immediate expenses such as payroll, utility bills, rent, and inventory. They also have to have cash on hand to pay off their outstanding loans. In most cases, businesses don’t have enough cash to cover all of these expenses at once.
If a company exhausts its cash reserves, it will face a liquidity crisis. This can be disastrous for a company’s operations, as it may not be able to pay its employees or buy the inventory needed to keep the business running. The best way to prevent this from happening is through supply chain finance.
Why Is Supply Chain Finance Bad?
The terms of supply chain finance are usually less favorable than those offered by banks. This is because the lender is relying on the company’s assets as collateral (or security) if they cannot repay their debt. The lender is also less likely to provide a grace period before considering default.
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