Supply chain finance is when a firm in the supply chain, either a manufacturer, retailer or supplier, supplies financing for part of the rest of the chain. Often, by creating financing from within the supply chain, the entire process of producing a product can become more predictable and more profitable.
Traditional Supply Chain Financing Options
- Factoring: This is what is typically thought of as supply chain financing, when a supplier sells their accounts receivables at a discount to a financial counterparty in order to get cash today so they can finance part of their ongoing operations. The manufacturer or buyer isn’t involved at all, other than through purchasing the end product.
- Trade credit: This is affected significantly by the marginal production cost of the goods sold. When the marginal cost is low because the product is scaling, trade credits better than bank loans. However, when the marginal cost of goods are high, bank loans actually yield higher profits in the supply chain, particularly to the manufacturer.
- Invoice Discounting: When a supplier gets loans from a creditor using discounted accounts receivable, somewhat like factoring, as collateral. While the creditor is often a third party, it can occasionally be a larger party in the supply chain.
- Supplier Subsidies: This is when a manufacturer uses their own funds to offer lower rate financing options for suppliers, instead of relying on their suppliers to get outside financing. While in-house lending arms have existed for 50+ years at places like GM\, most people don’t realize the effect it had during the 2008 crisis. GM loaned out hundreds of millions of dollars in order to keep suppliers solvent so it could continue shipping vehicles that depended on their parts. This is very common in non-commodity industries.
Less Traditional Supply Chain Financing Options
- Reverse Factoring: Somewhat like traditional factoring where a supplier gets a loan from an outside financier based on accounts receivable, except that in this case the buyer is committing to pay the creditor on the set date. Reduces the risk and lowers costs through the supply chain since the financing costs and rates are based on the larger manufacturer’s credit rating rather than the lower rating of the smaller supplier. In many cases, “buyers have achieved an average working capital reduction of 13%” by using reverse factoring.
- Currency Risk Sharing: Allows suppliers and buyers to offset the risk of currency changes during the course of a manufacturing contract. By splitting the risk of any currency rate fluctuations, each side is affected by half as much as they otherwise would be affected. Can significantly increase the robustness of a cross-border agreement.