Supply Chain Finance Seems to have a New Possibility
Since the dawn of modern production and distribution, supply chain management has been tasked with organizing resource flows in the manufacture and sale of goods. Internal resources or external working capital finance are used to fund input purchases, labor, and other aspects of production and distribution (unless the buyer pays before production).
A multinational firm could fund the working capital for its supply chain in a fully integrated production process. However, as the fabrication of commodities has gotten more specialized and globalized, industrial processes have become more complex, and supply chains have become more dispersed. Financing requirements across a complicated range of relationships are no longer absorbed by a single party for most businesses.
Information technology advancements have facilitated the expansion and complexity of supply chains, as well as the potential for specialization and scale. These same technologies may be used to assess risk and enable financial service providers to lend loans to a growing number of supply chain participants.
What is Supply Chain Finance?
The provision of credit connected to open account transactions between a supplier and a buyer, where the sale occurs through the submission of an invoice and without the use of a third-party guarantee, a contract, or instant payment, is known as supply chain financing.
Open account terms are typically defined as an agreement between a buyer and a seller to pay within 30, 60, or 90 days of the invoice’s submission. A bank or financial intermediary is not involved in this sort of deal until the invoice is either acquired or leveraged for financing. The financing of an outstanding receivable or payable to a buyer or seller for a period of 30 to 90 days is referred to as supply chain finance solutions.
Trade finance (i.e., the financing of transactions across national borders where recourse options are limited and difficult to enforce) is often related to supply chain finance. With trade finance, participating financial institutions may take on risks on behalf of clients they are familiar with, acting as a proxy source of confidence among established bank networks and allowing the transaction to proceed.
Traditional working capital lines or open lines of credit are more expensive than SCF alternatives. While working capital lines offer more flexibility, they also come with more risks and higher origination fees. SCF transactions are often less expensive than other working capital finance options since they analyze the risk of payment between two parties in an open account transaction.
In traditional working capital loans, financial institutions evaluate risk based on the borrower’s credit history, past financial performance, and collateral availability. This has made lending unsustainable for SMEs in emerging nations, as information is costly to get and analyze, and the expenses of monitoring and gathering also outweigh the potential profits for banks. Furthermore, the lengthy application procedures, documentation requirements, and review times may only partially meet the business’s working capital needs.
Supply chain finance options for SMEs and the value chains of mid-size corporate entities have traditionally been limited due to high onboarding costs and communication obstacles.
Technology and business model improvements, on the other hand, are rapidly reducing these barriers and opening up new financing alternatives for supply chain transactions for both funders and borrowers.
The advantages of starting or extending an SCF portfolio and entering the SME market for lenders are numerous:
- A less risky/easier way to get started with business finance.
- Strong financial provider networks can lead to a greater range of corporate services.
- Strong finance networks can aid in increased consumer market penetration.
- More opportunities to extend lending while reducing risk exposure with shorter-term, targeted credit
Traditionally, supply chains were made up of a succession of essentially distinct, segregated phases (for example, product creation, manufacturing, distribution, and sales).
The chain became a fully connected ecosystem with transparency for all actors involved, from the suppliers of raw materials, components, and parts through the carriers of those supplies and finished goods, and finally to the client, thanks to digitization. Planning and execution systems, smart procurement, logistics, and warehousing visibility, and advanced analytics all made progress on these fronts. These benefits have ramifications for the supply chain as well as, more crucially, supply chain financing.
Supply chain finance has evolved in lockstep with supply chain management change. Supply chain finance used to entail improving working capital ratios and providing funding sources to a corporation before the effect of technology. Because supply chains are becoming more collaborative and diffused, corporate anchors at the top of the chain must ensure that a larger range of supply chain partners (i.e., suppliers and distributors) have adequate working capital to maintain production and business continuity.
Through leveraging data from integrated supply chains, supply chain finance can now extend beyond the first tier of suppliers and distributors to those whose overall financial status may not be visible to an anchor or its partner financial institutions. Extending financing to these players (often SMEs) requires new models for assessing risk and interfacing with clients.
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