What is Supply Chain Finance: A Simple Guide

India’s economy thrives on the backbone of its small and medium enterprises (SMEs), which contribute significantly to its GDP and employment. However, these businesses often face liquidity challenges due to delayed payments and rising operational costs. In this context, Supply Chain Financing (SCF) has emerged as a critical financial tool to bridge the gap between suppliers and buyers, ensuring steady cash flow and operational efficiency.

In 2024, SCF has gained even greater prominence as businesses adapt to evolving global economic conditions and post-pandemic disruptions. With the supply chain finance market in India valued at approximately ₹60,000 crore and poised for rapid growth, it is clear that this financing model plays a pivotal role in supporting SMEs. By easing payment bottlenecks, SCF has become indispensable for sustaining growth in India’s dynamic economy.

This blog explores the workings of supply chain financing (SCF), its various types, benefits, challenges, and the opportunities it presents for businesses.

‍

What is Supply Chain Financing?

Supply Chain Finance (SCF) is a financing solution that helps buyers and sellers streamline transactions and manage cash flow more efficiently. It uses technology to automate processes like invoice approval and payment, allowing suppliers to get paid faster while giving buyers more time to settle their bills.

SCF leverages the buyer's creditworthiness to facilitate early supplier payments, ensuring liquidity without adding debt to either party’s balance sheet. This system is typically supported by banks and financial institutions, which provide short-term credit to improve cash flow and reduce costs. It is especially beneficial for startups, MSMEs, and business owners, as it helps manage cash flow challenges, maintain strong supplier relationships, and reduce financial risks.

Key Steps in the Supply Chain Finance Process:

1. Purchase and Invoicing
   • The buyer purchases goods or services from the supplier.
   • The supplier issues an invoice with a specific payment term (e.g., 30, 60, or 90 days).
2. Invoice Approval
   • The buyer reviews the invoice for accuracy and approves it for payment.
3. Early Payment Request
   • The supplier requests early payment for the approved invoice through a financing institution.
4. Payment Disbursement
   • The financing institution disburses the payment to the supplier, deducting a small fee for the service.
5. Settlement
   • On the invoice due date, the buyer pays the financing institution the full invoice amount.

This flow ensures that suppliers receive timely payments, improving their liquidity, while buyers gain the flexibility to extend payment terms, helping both parties optimize their working capital.

‍

Types of Supply Chain Financing Products

Supply chain financing products can be divided into 2 categories:

Supply chain financing products can be broadly categorized into two types: receivables-based financing and loan-based financing.

Receivables-Based Financing

• Factoring: The supplier sells their receivables (amounts owed by debtors) to a finance provider at a discount. The finance provider takes over the responsibility of collecting the owed amount from the debtors, charging a fee for this service.
• Receivables Discounting: This involves obtaining a loan against the accounts receivables from finance providers. Suppliers get loans based on their outstanding receivables, after adjusting for any doubtful or bad debts.
• Reverse Factoring (Payable Financing): Here, the supplier receives an advance from the finance provider to pay off their payables and receive early payment discounts.
• Forfaiting: Exporters sell their medium or long-term receivables to finance providers to get immediate cash. This helps exporters quickly access funds and reduces the hassle of collecting payments from importers.

Loan-Based Financing

• Distributor Finance: Distributors get loans by selling their receivables or other current assets to finance providers. This helps cover the costs of holding goods for resale and maintaining liquidity.
• Pre-Shipment Finance: Exporters receive loans to fund the purchasing, manufacturing, and packing of goods before shipment. Also known as packing credit, it facilitates the smooth execution of export orders.
• Advance Against Inventory: Businesses obtain loans using their inventory as security. This helps manage the costs associated with holding inventory.
• Advance Against Receivables: Companies get loans based on their trade receivables, allowing them to receive payments early and meet their liquidity needs while giving customers flexible payment terms.

While both receivables-based and loan-based financing products aim to improve cash flow and liquidity, they serve different purposes and address distinct financial needs within the supply chain.

‍

Benefits of Supply Chain Financing

• Improved Cash Flow: Provides early payment to suppliers, ensuring steady cash flow and reducing reliance on loans.
• Reduced Financial Risks: Mitigates risks of delayed payments and supply chain disruptions, ensuring stability.
• Optimized Working Capital: Frees up capital for strategic investments like scaling, hiring, or product development.
• Opportunities for Growth: Enables businesses to reinvest liquidity into expanding operations or entering new markets.

‍

Challenges in Supply Chain Finance 

• Access to Financing: Many SMEs struggle with limited credit history or collateral, making it difficult to access supply chain finance options.
• Complexity and Standardization: The involvement of multiple parties and cross-border transactions adds complexity, making standardization challenging.
• Risk Management: Financial institutions face difficulties managing risks related to supply chain disruptions, buyer and supplier reliability, and fraud.
• Regulatory Compliance: Navigating varying international and domestic regulations can complicate cross-border transactions and the implementation of SCF solutions.
• Data Security: Ensuring the security and privacy of sensitive financial data requires robust cybersecurity measures.

‍

FAQs 

Q1 Is supply chain financing only for large businesses?

No, supply chain financing (SCF) suits businesses of all sizes within a supply chain ecosystem, not just large businesses. Small and medium-sized enterprises (SMEs) can also benefit from improved cash flow and reduced financial risks through SCF.

Q2 What role can NBFCs play in the SCF landscape in India?

Non-Banking Financial Companies (NBFCs) play a significant role in the SCF landscape in India by providing financial services and enabling financial inclusion across various industrial sectors. They help bridge the gap for MSMEs that may not meet the traditional banking system's criteria, offering them access to low-cost and efficient financing.

Q3 Supply chain financing vs. factoring – what is the difference?

Supply chain financing (SCF) and factoring are both financing solutions, but they differ in key ways:

SCF is a buyer-led solution that helps suppliers get paid faster while enabling buyers to manage their cash flow more effectively. It involves a tripartite agreement between the buyer, supplier, and financial institution.
On the other hand, Factoring involves a business selling its accounts receivable (invoices) to a third party (factor) at a discount for immediate cash. The factor then collects payment from the buyer.

Q4 How does supply chain financing benefit banks and financial institutions?

Supply chain financing benefits banks and financial institutions by providing them with opportunities to offer new financial products and services, improve their relationships with corporate clients, and enhance their risk management practices. It also helps them optimize their cash flow and working capital management.

Q5 Can supply chain financing be used in international trade?

Yes, supply chain financing can be used in international trade to facilitate smoother transactions and improve cash flow for businesses involved in cross-border trade. It helps reduce the financial risks associated with international transactions and supports the efficient movement of goods and services across borders.

‍

Conclusion

Supply chain finance (SCF) is a powerful tool that enhances cash flow, strengthens supplier relationships, and reduces financial risks. By choosing the right SCF products and addressing challenges like regulatory compliance and data security, businesses can significantly improve their financial health. With the rise of digital platforms and innovations, SCF continues to evolve, offering even greater benefits. 

Recur Club’s financial experts are ready to help you design an SCF strategy tailored specifically to your business needs, optimizing your operations and maximizing efficiency. With access to over 125 lenders—including industry leaders like Tata Capital and HSBC, we ensure the best funding options are available to support your financial journey.

Take the next step in your financial journey. Connect with Recur Club today to discover how to leverage supply chain finance for business success!