Supply chain finance: silver bullet for working capital

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Supply chain finance (SCF) is seeing a huge amount of interest from organisations of all sizes – yet there’s a lack of consensus even over exactly what it is. We show exactly what it can do, how it connects with trade finance, and how it benefits working capital management for exporters and importers, and ultimately the importance of taking a holistic view when integrating SCF into the wider context of your processes.

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Demystifying SCF

SCF is seeing a huge amount of interest from organisations of all sizes. No matter whether you measure by value, volume of transactions or number of parties involved, banks and industry bodies are reporting double-digit growth.

For example, Demica research focusing on major international banks found 30% to 40% annual growth rates in SCF programmes, with technology and the growth of e-invoicing systems seen as significant market accelerators.

And it’s no wonder. For businesses in many industries, credit is tight. And as operations grow increasingly global, the working capital needed to finance the operation of the supply chain, particularly in cross-border transactions, becomes a real focus area.

But organisations looking at SCF will find themselves in a fast-changing sector lacking even consensus on what the term SCF means.

We at Nordea chair the Euro Banking Association (EBA) Supply Chain Working Group, which among other key focus areas is helping standardise a common terminology for the financial supply chain as part of a regularly updated market guide.

The EBA defines SCF as:

The use of financial instruments, practices and technologies to optimise the management of the working capital and liquidity tied up in supply chain processes for collaborating business partners. SCF is largely ‘event-driven’. Each intervention (finance, risk mitigation or payment) in the financial supply chain is driven by an event in the physical supply chain. The development of advanced technologies to track and control events in the physical supply chain creates opportunities to automate the initiation of SCF interventions.

Aligning cash-goods movement

The EBA definition puts SCF in the broader context of physical and financial supply chain management. It’s vital for businesses to look at how their operational processes and practices can help optimise liquidity and working capital – and bank SCF services should provide a strong supporting role.

The increased implementation of electronic invoicing and document exchange, automation and other digitalisation practices, for example, are facilitating the adoption of SCF. But they can also help support working capital management in their own right, by reducing delays and friction in the movement of goods and money throughout the supply chain.

There are many different kinds of supply chain finance – some formal and ongoing, some more ad hoc, with different levels of cost and security to suit the level of risk in the transaction.

SCF includes instruments for financing accounts receivables (such as factoring and discounting), financing suppliers through approved payables financing, inventory finance, and traditional documentary trade finance products.

What all these solutions share is an emphasis on benefiting both buyer and seller – reconciling the often opposing needs of exporter and importer by improving cash flow and covering risk.

Benefits for every link in the chain

Exporters ultimately want a guarantee they’ll be paid for the goods they’ve shipped – conventional trade finance instruments take care of that. But they also want to make sure they’ll be paid promptly, to tighten up the cash conversion cycle.

Just as with invoices in domestic transactions, exporters can sell trade finance instruments – such as letters of credit – at a discount to their bank, eliminating the wait for payment and funding the delivery.

Alternatively, these instruments can be used as security to back access to credit facilities, easing the strain on other sources of credit – that is important when the availability of bank credit is tight.

It is also possible for exporters to transfer the letter of credit down the supply chain line to their own suppliers, who in turn can use it to obtain funding.

Importers, for their part, want to hang on to their cash for as long as possible, and may be pushing to extend their payment terms to optimise working capital. But they also want to make sure that suppliers, particularly smaller ones, don’t become insolvent.

They know that suppliers can themselves use supply chain finance to get quick access to cash by selling receivables. But big, powerful buyers, such as supermarkets or automotive companies, can use SCF to offer smaller suppliers access to cheaper credit by leveraging their strong credit ratings.

In this way, SCF is a way to recirculate funding from the strongest links in the supply chain to the weaker parties, which is an obvious advantage in an economic climate where credit availability is still tight.

SCF should not be used in isolation

Every business and every supply chain is different, however. When looking at adopting SCF, there are a range of factors that organisations need to consider, including how to onboard suppliers and buyers (which can include thorough 'know your customer' style compliance checks familiar to any company that uses trade finance) and which technology platforms should be used to exchange invoices, letters of credit and other documents between suppliers, customers and their banks.

Most importantly, businesses need to start by considering the wider cash-flow and working capital issues they’re trying to solve, and look holistically at the techniques they can employ to improve their overall financial profile at the lowest cost.

Banks offer a range of services, and organisations can conduct a range of activities internally, that individually or collectively are just as effective at maintaining cash flow and working capital levels.

For instance, an organisation might benefit from renegotiating supplier payment terms and other elements of the purchase and sale cycles, reducing inventory, pooling account structures to free up cash, managing risk by improving forecasting accuracy, or using standard bank credit facilities – even overdrafts – to fund supply chain operations.

Joint, cross-functional approach

At Nordea, we recommend that customers looking at working capital begin with their processes and consider all of the tools at their disposal – including changes to processes – not just banking products or financial technologies.

That’s why, when we talk to clients that are looking for help with SCF, we always invite them to think about their broader objectives and where the challenges lie at each stage of their OTC, P2P and treasury processes.

We encourage them to hold joint meetings that bring together representatives from all the relevant business teams, and we bring ours, too: not just from trade finance, but from our cash management, markets and finance divisions as well. We challenge them to work together to build powerful solutions.

To find out how SCF can work alongside trade finance and other instruments to help you achieve your working capital management goals, get in touch. Alternatively, read our article on working capital management for more on the holistic view and approach that we recommend.