Traditionally, invoice finance instruments like factoring are considered credit products for suppliers. However, the need for factoring usually stems from buyers, who need long payment terms to align incoming and outgoing cash flows, release working capital, and mitigate supply chain risk. Extended payment terms strain suppliers and ultimately increase working capital costs throughout the supply chain. Recognising the adverse effects for suppliers and buyers alike, buyers can take on a greater role in accelerating suppliers’ cash flows by implementing supply chain finance solutions. This article will take a closer look at how such solutions benefit the buyers.
Which invoice finance benefits do buyers get?
There are different financing solutions initiated and managed by the buyer. These include reverse factoring, dynamic discounting and supporting traditional factoring with recourse to the supplier. Such solutions allow buyers to manage processes and set their own conditions. However, before looking at the particular instruments, it’s important to understand what alternatives suppliers have, and what makes buyer-led programs so compelling.
Why do suppliers often prefer invoice financing over simpler overdraft limits, which are typically compared to factoring?
First, the terms of payment by the debtor of the assigned claim depend on the deferred payment agreed by the supplier and the debtor. While factoring deferment can be up to a year, overdrafts are shorter, covering the short-term needs of the supplier in cash. Therefore, the period of overdraft can be up to one year, but with the recalculation every 3 months.
Second, factoring limits are usually much higher than overdraft limits. Unlike factoring limits, which are mainly based on the credit quality of the debtor, overdraft limits are calculated as a fraction of the average monthly income on the customer’s bank account. Factoring, however, allows mitigating credit risk based on known cash flows and takes into account the actual trade volumes.
Third, true factoring does not require collateral and does not increase the debt burden on the balance sheet. This nuance is critical for companies who don’t have collateral to provide - it may already be pledged to other loans or the company does not have fixed assets altogether.
Having established why invoice financing offers greater value to suppliers, it’s important to understand the buyer’s motivation in financing their suppliers.
The main idea behind supply chain finance is to reduce the supplier’s working capital costs by relying on the strong credit profile of the buyer. Having suppliers arrange their working capital limits independently can be expensive in terms of the particular interest rate, but also as it ties down the supplier’s balance sheet and requires greater managerial effort. It’s the buyer who ultimately carries the cost, even if it is disguised in the final purchase price.
Supply chain finance instruments help mitigate that risk and in fact increase the buyer’s bargaining power in supplier relations.
With supply chain finance instruments, the buyer benefits both financially and operationally. When considering the benefits, SCF helps buyers to:
Therefore, the use of invoice finance tools usually has a positive effect on both sides of the supply. The supplier receives early payment. As a result, cash flow improves. The buyer also receives a number of benefits: from optimizing the balance sheet and additional working capital, to reducing the cost of procurement, as well as incentives for their suppliers. This win-win solution can change the collaboration of suppliers and buyers for the better.