Supply chain finance
A financing arrangement in which a bank pays a buyer's suppliers early, at a small discount, while the buyer pays the bank on the original due date.
In short
- It is also called reverse factoring, because the buyer sets it up rather than the supplier.
- The discount reflects the buyer's credit rating, which is usually better than the supplier's.
- Accounting standards now require buyers to disclose these programs.
Supply chain finance, often called reverse factoring, lets suppliers get paid early on approved invoices without the buyer paying early. A bank or finance provider pays the supplier soon after the buyer approves the invoice, minus a small fee. The buyer then pays the full amount to the bank on the invoice's normal due date, or sometimes later.
Why it exists
Large buyers often want longer payment terms, while their suppliers want faster payment. Supply chain finance lets both happen. Because the bank is relying on the buyer's promise to pay, the financing cost is based on the buyer's credit, which is usually cheaper than what the supplier could get on its own through factoring or a loan.
Supply chain finance versus factoring
In ordinary factoring, the supplier sells its receivables to a financier, and the cost depends on the supplier's customers and its own credit. In reverse factoring, the buyer sets up the program and confirms which invoices are approved, which reduces the financier's risk.
Risks and disclosure
Programs can hide how much a buyer really owes, since payables can be stretched well beyond normal terms. After some high-profile failures, accounting standards were amended: both IFRS and US GAAP now require buyers to disclose the terms and amounts of supplier finance arrangements.
Worked example
A supplier paid on day 10 instead of day 90
A retailer approves a $200,000 invoice on 90-day terms. Through the retailer's program, the supplier chooses to be paid on day 10 and receives $200,000 minus a fee of about 1.1%, or $197,800. On day 90, the retailer pays $200,000 to the bank. The supplier gets cash 80 days early at a rate based on the retailer's credit, not its own.