Today’s Treasurers and CFOs are constantly looking for new and better opportunities to maximize working capital and minimize counterparty risk in their company’s physical supply chain. As organizations become more global and increase the scope and complexity of their supply chain, it is a challenge that is becoming more relevant every day.
In response to these challenges, many organizations have implemented Supply Chain Finance programs in an effort to provide financial benefits for their suppliers and their own working capital.
What is Supply Chain Finance?
Supply Chain Finance is the management of cash and capital to support a company’s physical supply chain. The objective of Supply Chain Finance is to provide supplier financing to enable companies to trade on open account terms, without the use of traditional trade financing methods like letters of credit – which are expensive, time consuming and paper intensive. One Supply Chain Finance method that has been gaining traction in recent years with large corporations is Payables Financing (or Reverse Factoring).
How are Payables Financing Programs Structured?
By utilizing Payables Financing, a third party bank will fund the supplier the full value of approved invoices, less any financing costs, typically within days of invoice approval. The buyer pays the full value of the invoice to the bank on the due date of the invoice. The financing costs associated with the discount are based on the buyer’s credit. This method allows buyers to maintain or extend payment terms while ensuring their suppliers have access to capital based on the buyer’s credit.
From an operational viewpoint, the buyer:
- Sets up its Payable Financing Program on a secure, easy-to-use technology platform where the buyer, its suppliers and banking partners have complete visibility of invoices approved for payment.
- Determines which suppliers should be onboarded to the program.
- Invites its banking partners to join the program and in conjunction with the banks, establishes financial terms for the early payment of invoices.
Suppliers can view approved invoices on the platform and have the option of selecting invoices to obtain early payment financing from participating banks in the program.
Benefits for Buyers
Well-managed Payables Financing Programs yield three important benefits:
Improved Working Capital
A good Payables Financing Program gives buyers access to additional sources of unsecured liquidity. In essence, it uncovers free cash for the time period between the extended payment date and the original payment date of the invoices. When spread over the entire payables “bucket,” the value of unsecured liquidity can be tremendous. This technique also allows buyers to improve their payment terms without impacting the liquidity of their suppliers.
Visibility into cash and liquidity is the cornerstone of an effective Payables Financing Program. From the buyer’s perspective, when CFOs and treasurers have greater visibility into their cash and liquidity positions, they can make more informed working capital decisions. All internal stakeholders – the treasurer, accounts payable, procurement and other departments – require concurrent access to the same data to ensure better decision-making. The most effective programs integrate the needs of the buyer’s internal stakeholders with its external partners – all with the goal of fostering better collaboration.
A Payables Financing Program can also help buyers minimize potential disruptions in the supply chain due to lack of cash or liquidity. While many supply chain risks are beyond the control of the buyer, ensuring suppliers have the cash and liquidity to maintain and grow their operations is an area the buyer can positively affect.
Ironically, there is a risk that Payables Financing Programs become too successful and outgrow the funding limits of a single financing partner. As a result, many buyers choose to diversify their programs across multiple banking partners so that the program is not limited by one bank’s ability to offer financing to all suppliers. Further, for global programs, the buyer can partner with banks and other lenders that specialize in certain regions, which may encourage supplier participation in those parts of the world.
Benefits for Suppliers
Perhaps most importantly, Supply Chain Finance Programs, including Payables Financing, give the supplier access to cash earlier, improving their working capital at a better financing rate than they can achieve on their own. In most cases, the participating banks will fund 100% of the approved invoices less any financing costs, often Libor or a similar index plus a small spread. This is a significant value when compared to other forms of financing such as factoring, which will only advance 70% to 80% of invoice value to the supplier – and at a higher finance charge. More cash at a lower cost is good for suppliers.
Benefits for Financial Partners
There are many advantages for banks that offer Payables Financing Programs, not the least of which is the opportunity to generate new business opportunities from supplier organizations that may not previously have been customers. Payables Financing is also a friendly form of financing as it is short term and with limited risk, given the bank has only loaned funds to the supplier based on pre-approved invoices. Because there is a limited impact on liquidity ratios and reduced default risk, banks are more attracted than ever to offer Payables Financing.
The Right Technology is a ‘Must’
Technology is an enabler to achieving a company’s goals for their Payables Financing Program. Whether it is treasury or another department tasked with managing the program internally, technology provides the productivity and connectivity to allow a small team to manage the requirements of a growing program. Adding new headcount every time new suppliers are onboarded or new banks are added to the program simply isn’t necessary when technology can provide that scalability.
Key Technology Features
- Multi-bank: Buyers need the flexibility to work with multiple banks, without adding complexity or significant hours (or days!) to the team’s workload. The platform should make it as easy to connect to multiple banks as it is to connect to a single bank.
- Global: Large corporations today have global supply chains, so they need to be able to administer global Payables Financing Programs. The technology platform, just as the program itself, should support multiple geographies, currencies and languages. Technology should facilitate, instead of limiting, the program’s geographic reach.
- Easy to use, easy to onboard suppliers: Without supplier involvement, an organization cannot run a successful Payables Financing Program. A good, intuitive user experience will encourage, rather than hinder, supplier use of the system and, as a result, supplier participation in the program. Suppliers need pure web-access, minimal mouse clicks and a structured workflow to effectively use the system.
- Automation: The platform should automate a variety of tasks and workflows so that buyers, suppliers and banks have full visibility of invoices; can effectively make working capital decisions knowing the impact on the cash forecast; and eliminate all re-keying to approve and release payments. A scalable solution will improve productivity without an increase in staffing.
- Web-based. A pure web (or Software-as-a-Service) solution enables companies to launch their program more quickly, without making significant financial or IT investments.
With these key features, companies would have a platform in place to launch and manage a global Payables Financing Program.
Bottom Line: Positioned for Growth
When executed effectively, a Payables Financing Program helps buyers optimize working capital while reducing counterparty risk in the supply chain. Buyers can also use the program to help their suppliers achieve a more stable financial foundation, positioning the supplier to grow as the buyer grows. Banks benefit by entering into financial partnerships that can yield a growing revenue stream as the supplier network grows.
Technology is the catalyst that makes this collaboration feasible in a today’s global economy.