Supply Chain Financing Through Reverse Factoring

Spend Matters welcomes another guest post from Santosh Nair of GEP.

Supplier collaboration has long been recognized as a critical competitive advantage for leading companies. At GEP, we’ve seen and helped many clients unlock value through innovative supplier approaches such as new product development, process reengineering, joint investments, and product standardization. In recent times, we’re seeing much higher engagement from the finance function to support and drive such innovation.

One such program is supply chain financing (through reverse factoring) that puts finance in the center of procurement innovation and drives working capital improvement, among other benefits. Most traditional efforts to free up cash flow are focused on inventory management or squeezing suppliers for better payment terms. This approach soon displays diminishing returns while introducing risk into the supply chain and souring supplier relationships. An alternate mechanism called “factoring” has been used in a few areas wherein the supplier sells its accounts receivable to a lender at a discount. This provides immediate cash to suppliers, but the process is cumbersome and largely inefficient, and ignores the buyer community.

I’ve been involved in several projects implementing a more innovative solution of “reverse factoring” requiring buyer collaboration, particularly finance and treasury. In this case, buyers use their higher credit rating to get cheaper finance for suppliers and benefit from the intermediary funding source. In practice, the buyer selects a third party funding source or bank. Suppliers send invoices to the buyer for approval through the bank system. Once approved by the buyers, the supplier can work with the bank to either get paid early (with finance charge discounts) or wait longer. The finance charges are mainly driven by the buyer’s credit relationship with the bank. The bank will pay the suppliers accordingly and will then collect invoice payments from the buyer, usually later than the original invoice date. The systems can be set up to allow multiple funding sources, dynamic negotiations with each supplier, customized real-time financing options, etc. I’ve received extremely positive feedback from all concerned stakeholders in this arrangement due to the following reasons:

  • The supplier receives access to an attractive form of financing, which is likely better than what they could secure on their own. They also have the option to improve their cash flow through early payment, should they choose to execute it.
  • The buyer is able to use its credit rating to infuse cash efficiencies into the supply chain. Buyer working capital is freed up by being able to delay payments without negatively affecting supplier cash flow or relationships. This also reduces supply chain disruption risk .
  • The bank is able to tap into a large pool of suppliers at low risk, due to the buyer’s credit rating.

While there are significant benefits to this approach, successful implementation requires upfront investment of time and expertise. High levels of collaboration are needed between Finance, Treasury, Legal, and Procurement. The right funding partner and technology platform have to be selected, with capabilities aligned with the client requirements. The right selection framework must also be used to identify suppliers for program enrolment. Appropriate communication mechanisms and on-boarding processes follow before the system begins to function smoothly and generate tremendous value for all stakeholders involved.

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