What is Supply Chain Finance?

Supply chain finance (SCF) has been on the minds of many business owners over the past few years. It helps buyers and suppliers access working capital in times of economic uncertainty. According to a 2023 report published by BCR, experts estimate that global supply chain finance volumes increased by 21% between 2021 and 2022. 

As demand for the service grows, fintech companies are stepping in to offer more innovative SCF models and address some of the efficiency gaps presented by traditional bank-led solutions.

As a supplier, you may have heard the term or even encountered supply chain finance programmes through your buyers. What exactly is supply chain finance and how has the practice evolved?

What is supply chain finance?

Supply chain finance, also called reverse factoring, is a type of financing in which a third-party lender funds early supplier payments on behalf of the buyer. SCF is a short-term borrowing agreement used to settle your invoices before the invoice maturity date. Supply chain finance solutions allow buyers to hold on to their working capital for longer, while early payments improve your cash flow and strengthen the supply chain. 

Supply chain finance programmes are initiated by buyers. Here’s how a typical SCF arrangement works:

1. A buyer partners with a lender, typically a bank or fintech company, to fund a supply chain finance programme.
2. The buyer invites you to participate in the programme.
3. When you submit invoices, you receive early payments from the lender in exchange for a lender-determined discount.
4. The buyer then pays the lender in full within the agreed term and the lender gains from the difference.

SCF lenders base programme costs on the buyer’s credit rating, not the supplier’s. As a result, SCF can give you access to capital at more affordable rates than through other financing solutions, such as a business loan from a bank. 

When suppliers receive quick invoice payments and buyers can delay accounts payable, both parties improve liquidity. This helps businesses continue operating smoothly or redirect increased cash flow to growth initiatives, supporting more innovative and stable supply chains.

How has supply chain finance evolved?

Supply chain finance has its roots in trade finance (solutions that facilitate trade and reduce trade risks for buyers and suppliers). Trade finance activities can be traced to as far back as 3000 B.C. Supply chain finance, however, only started in the 1980s, when interest rates and funding costs were high. Supply chain finance was an innovative financing option for corporations and their suppliers, and more commonly used in the automotive, retail and manufacturing industries in the 1990s. 

Globalisation has created highly complex supply chain networks involving thousands of suppliers. As a result, bilateral trade finance processes, such as letters of credit, lost ground in favor of open account trade. Open account trade — a “buy now, pay later” approach in which goods are shipped and received before payment is due — is more cost-effective and efficient for buyers than previous trade finance methods. Today, an estimated 80% of global trade happens on an open account basis.

Suppliers, however, accept considerable risk with open account transactions, facing the potential for nonpayment. Many suppliers also wait upwards of 90 days to receive payments for goods they have already invested resources into providing, and lengthy payment terms can quickly deplete working capital. This sets the stage for a thriving supply chain finance ecosystem: Buyers can maintain the benefits of open account terms while suppliers mitigate risk by accepting early lender payments in exchange for a discount.

Supply chain finance gained popularity during the Great Recession and again in 2020 due to COVID-19. In both cases, SCF gave buyers a relatively easy and cost-effective way to access liquidity and protect their supply chains during economic uncertainty. Inflation, rising interest rates and persistent supply chain disruptions have only increased supply chain finance usage. 

Many fintech companies have recognised the growing demand for supply chain finance. The industry is rapidly evolving as non-bank providers enter the space to offer more innovative, efficient SCF technologies.

Dynamic Supplier Finance: A new spin on SCF

While supply chain finance is meant to be a win-win solution, buyers typically see low supplier participation when they use traditional bank-led programmes. Small to midsize suppliers are deterred by the resource-intensive onboarding processes, costs and rigid terms. In some cases, buyers may even use supply chain finance programmes as leverage to extend supplier payment terms. Buyers can also use SCF programmes for their largest suppliers with higher invoice amounts available, which can exclude smaller suppliers with lower outstanding payments who made have a greater need for faster invoice payments.

Many emerging supply chain finance solutions aim to address these disadvantages by ensuring win-win terms and making access to SCF easier for suppliers. One example of such a solution is C2FO’s Dynamic Supplier Finance, which gives both parties more flexibility than traditional SCF programmes. Here’s how:

• Suppliers set their own target discount rates and decide which invoices to accelerate. 
• If the buyer accepts the discount offer, it can choose to fund early payment itself or through a network of third-party lenders. 
• Because the solution is user-friendly and easy to set up, suppliers can avoid the complex onboarding processes associated with banks.

Put simply, Dynamic Supplier Finance is an early payment programme where buyers can opt to fund early payments via lenders whenever it makes sense for their balance sheets. 

This approach has several advantages over many bank-led supply chain finance programmes. With easy setup and more agency over payment terms, suppliers are more likely to participate, supporting a more resilient, well-funded supply chain. The option to fund early payments with or without third-party lenders also gives buyers more flexibility and ensures that both parties can continue accessing funds — even when a crisis might otherwise prompt banks to cancel SCF programmes.

In summary

Supply chain finance has existed for decades, giving buyers and suppliers easier access to working capital by using a financier to fund early invoice payments. The practice has seen a few periods of growth since the 1980s, coinciding with volatile economic conditions and high borrowing costs. During an economic downturn, buyers have turned to supply chain finance as a low-barrier solution to increasing liquidity and maintaining the stability of their supply chains.

The SCF industry has thrived since 2020 for these very reasons, helping businesses navigate one of the biggest economic disruptions in recent memory. As demand for supply chain finance grows, it’s no surprise that the industry is quickly evolving. Fintech solutions are giving businesses more options than ever when implementing supply chain finance, granting buyers and suppliers greater flexibility than traditional programmes.

Interested in supply chain finance alternatives? Early payment programmes help your business get paid faster, whether or not your buyer already uses an SCF programme. Learn more here.

This article originally published May 2020, and was updated August 2023.