Compatible with technology supply chain finance has been around for over 20 years, promising the release of huge amounts of stranded working capital from the supply chain. Large companies can use their credit to finance supply chain finance programs, but midsize buyers find it difficult or too expensive. This restricts supply chain finance large buyers; very few programs are offered by mid-sized companies. And, with historically low interest rates making the cost appear high, along with seemingly endless contract complexity, vendors remain indifferent.
There are ongoing efforts by the supply chain finance service providers to reduce transaction risk for midsize buyers with deeper levels of integration – using sales order information, historical business data, and even receivables to bolster their credit rating and secure financing competitive. But at the same time supply chain finance remains a luxury offered only by top buyers and as the cost and complexity of the programs outweigh the obvious benefits, we aren’t going to see widespread adoption anytime soon.
Suppliers have always looked for ways to get their money before their buyers are ready to release it. Whether it’s through factoring, invoice discounting, or supply chain financing, the business world has come up with a myriad of ways to get money faster. Indeed, many “modern” companies seem to have forgotten the purpose of commercial payment terms.
Commercial payment terms were initially put in place so that the receiving party could verify that their goods had been successfully delivered before paying for them. Commercial payment terms were never intended as a complex arrangement that allows buyers to hold cash for an extended period of time and starve their supply chain. Nonetheless, this is where we are today and, unfortunately, the problem appears to have become part of standard business practice.
In an age of very low interest rates, extending payment terms is a strange thing to do. Why would buyers want to hang on to cash and not earn interest on it, while their suppliers wait for payment? Low interest rates also mean that supply chain finance has become too expensive, but its problems don’t end there.
Here are several reasons why supply chain finance will continue to be disappointing in today’s business climate:
First, the interest rates are very, very low. As a result, supply chain finance as a means of financing invoices has become very expensive for a supplier. The cost of funds is usually only 1-2% APR, but supply chain finance companies add high overheads, which often results in supply chain finance, which costs more than 10% APR. This is prohibitive for many businesses in the new normal.
The second problem with supply chain finance is that there is a huge amount of money out there and banks are very keen to lend to businesses right now. A business with a reasonable track record can usually borrow the money it needs quickly, so supply chain finance tends to be increasingly used by businesses with serious financial problems. Even though most of the credit risk is borne by the buyer, high risk suppliers also add transaction risk, making supply chain finance riskier for its lenders. This means that lenders have further raised their interest rates, creating a vicious cycle where higher levels of risk drive interest rates up on an already expensive service.
The third major problem with supply chain finance is that it is a relatively low margin business model. The pressure from low interest rates, along with the fact that the type of providers that lack cash tend to be smaller providers, means that you need a large number of people opting for financing from. the supply chain to make a viable supply chain finance business. And each of these providers needs a complex service contract, which increases the cost of adopting the service.
As a result, we end up with the worst of all worlds, where supply chain finance providers have to charge interest rates that are too high, which means the providers only attract high risk users. and that the cost of integrating them into their service is too high. The users also tend to be quite small, so the supply chain finance business needs very large numbers of them to become viable.
Of course, things could change if borrowing (on the supply side) becomes more difficult, or if base interest rates rise to make supply chain finance more competitive compared to other methods. funding. However, the other fundamental problem with supply chain finance concerns the contracts used to define the agreements themselves. The increasing complexity and amount of bookkeeping involved in setting up most supply chain finance agreements mean that many don’t even get past the first hurdle of signing.
In short, many supply chain finance contracts are too complex and onerous to put in place. There are several reasons for this, but sSupply chain finance is a contract between two, three or even four parties, comprising:
· The supplier, who gets his money early.
· The buyer, who gets a discount on the total price paid for the goods or services.
· The financier, who can add liquidity to the transaction at an interest rate proportional to the risks he takes on the transaction.
· Finally, the supply chain service provider who acts as an intermediary, usually based on cloud technology nowadays, which allows the transaction to take place and earn a small margin on the transaction.
These parts must be “glued together” using a legally binding contract. However, without careful consideration, supply chain finance services can get bogged down in terms and conditions.
Here are some of the typical issues that can arise:
Like most B2B e-commerce services, supplier adoption of a supply chain finance system is a major concern. Each supplier is presented with a contract specifying the obligations, terms and even penalties in the event of non-compliance. Unfortunately, the need to sign a complex contract immediately shifts the supplier’s adoption of the finance function from the supplier to senior management. Most small suppliers, who are often the ones who want to finance the supply chain, hate big contracts. Good supply chain finance service providers do their best to make this as painless as possible. For example, some service providers have managed to condense the supplier’s contract into simple clickable terms, but it’s far from straightforward. Keep in mind that the provider is “loaned†money, and with all loans there are always conditions where repayment may be required.
If the buyer finances the supply chain finance themselves, then all they really do is a basic invoice discount, and you wonder if all the complexity of supply chain finance worth it. It may be easier to negotiate a good price with your suppliers and set up contactless electronic invoicing to pay them on reasonable terms in a reliable manner. The money that can be made from discounting bills is limited by the willingness of providers to pay excessive interest in exchange for convenience. Buyers who extend payment terms and then force supply chain finance to their suppliers are in real danger of alienating the same suppliers they depend on.
However, if the buyer uses a third party to finance supply chain finance, then they should think very carefully about how transactions are accounted for. Changing trade payables to short-term firm debt owed to a finance company could have a significant effect on the balance sheet. Some supply chain finance providers have imaginative methods of getting around debt reclassification, but any buyer embarking on supply chain finance should have this clear idea before they begin.
For the financier, it is the risk of “who bears the loss if a transaction goes wrong?” Who is the counterpart? Is it the supplier, the buyer or the provider of supply chain finance? Or is it all three? How many contracts do we need? Financial services companies love complex contracts. One of the biggest pitfalls is being buried in financial contractual terms. There is no easy answer to this, although the supply chain finance provider can sometimes cushion the worst of suppliers and buyers.
Finally, there’s the supply chain finance service provider sitting in the middle of it all, trying to make it happen and stick it all together. But, even the supply chain finance provider is a counterparty risk to the financier. And, of course, the margins are reduced with those pesky low interest rates. All of this makes supply chain finance extremely difficult to work on a large scale and, in most cases, unprofitable. It is not for the faint of heart.