Although the dark days of the financial crisis are behind us, risks and uncertainties remain and companies are under pressure to unlock the working capital trapped in their supply chains. Senior associate Don Brown explores the details.
Supply chain financing (also known as supplier finance or reverse factoring) (SCF) can often be an attractive way for companies to improve their working capital position by lengthening their payment terms to their suppliers.
It can also mean suppliers get paid earlier, resulting in a win-win situation for both the buyer and the supplier.
How does it work?
The buyer (typically a blue-chip corporate with many suppliers) introduces its suppliers to the financial institution (Funder) providing the SCF facility and the terms of business are agreed. The buyer then approves the supplier’s invoices and agrees to pay the Funder for these at a fixed future date. Because the Funder is comfortable with the stronger credit rating of the Buyer (and so the likelihood of payment on time), it is willing to make finance available to the suppler on better terms than it otherwise would.
The supplier assigns (i.e. sells) these invoices to the Funder at a pre-agreed discount rate and receives the funds immediately. The trigger for the provision of finance is the unconditional approval of the invoice for payment by the buyer. So, the buyer approves the supplier’s invoice and the Funder promptly pays the supplier.
The buyer then pays the principal amount owed at the invoice maturity / due date (or at another agreed date) directly to the Funder.
The financing is typically provided to the supplier by the Funder ‘without recourse’ i.e. if the buyer doesn’t pay, the Funder cannot seek payment from the supplier. However, it is common for the Funder to retain the ability to claim for breaches of representations and warranties by the supplier.
The Funder and the buyer will need to enter into a service agreement. This document will contain an undertaking from the buyer to the Funder to pay ‘approved for payment’ invoices and receivables.
The supplier will enter into a receivables purchase agreement with the Funder under which the supplier will provide the Funder with an assignment of the debts being financed.
SCF provides significant benefits for the buyer, its suppliers and the Funder.
The supplier obtains invoice financing from the Funder at a favourable rate – this is because the Funder relies on the creditworthiness of the buyer and can provide the financing at a financing cost aligned with the credit risk of the buyer. This results in a lower cost of funding for the supplier and enhances the supplier’s working capital, cash position and cost base.
SCF also strengthens the relationship between the buyer and its suppliers – in particular, the buyer may be able to negotiate longer payment terms or price discounts with its suppliers and thereby improve its working capital position.
The buyer also benefits from a stronger, more robust supply chain which improves reliability and certainty of supply for the buyer.
For the Funder, SCF offers high quality transaction-based short term finance based on the credit of a prime buyer and supporting the business objectives of both trading parties.
SCF has become increasingly popular in recent years as buyers have sought to extend their payment terms without damaging the financial health of their suppliers. In the current uncertain climate, this trend seems likely to continue.
For further information, please contact:
Don Brown, senior associate, Banking and Finance
T: 0207 653 1646