Supply chain finance has evolved in recent years, yet fallacies surrounding what it is, which types of businesses it’s aimed at, and what it’s for persist.
In practice, supply chain finance (SCF) is a tool to help fortify relationships between companies within a supply chain and ensure small and medium-sized enterprises (SMEs) are able to access low-cost capital based on the creditworthiness of their larger partners. Yet an old, negative mindset persists. We have to dispel the myths within the industry for its true value to be seen.
These are some of the more common false notions I have encountered in the industry.
Myth 1: SCF benefits only large companies
This widely held misconception was once true, but is no longer the case due to technological innovation. Previously, the focus was centred on providing SCF to the largest suppliers. Banks were the primary providers of the solutions and their highly manually approaches simply did not scale. In most supply chains, the largest 1% of suppliers accounted for approximately 60% of the expenditure. Understandably, SCF found its success originally with a small number of high-value suppliers.
However, when fintechs such as Taulia entered the market, technology was used to bridge the provision of finance to the thousands of suppliers accounting for the other 40% of expenditure. Using technology to streamline and automate the processes necessary to provide and manage SCF has meant that a greater number of suppliers can participate. Enabling all suppliers to access SCF helps further strengthen supply chains, and it enables small businesses, which are often most in need of cash, to access a low-cost option.
Myth 2: SCF leads to longer payment terms
This is a fairly simple myth to bust. SCF does not impact payment terms, it adds flexibility for suppliers. Typically, Company A, the buyer, has a contract with Company B, the supplier, which has an agreed upon payment term. SCF brings an option to Company B to receive payment sooner than the agreed term which is paid by a third party. Company A, the buyer that establishes the programme, repays the third party under the originally agreed terms of payment with Company B. The addition of the third party brings greater flexibility across the supply chain.
SCF is a tool that strengthens supply chains by enabling suppliers to access funding to meet their unique needs. Businesses are regularly adjusting their accounts payable processes, whether it’s frequency of payment runs, reducing the number of payment terms or standardising on a new term. During these periods of change, SCF often becomes front of mind and is offered to minimise any potential impact. It’s creating an option for suppliers that is completely independent of terms.
Myth 3: SCF is used to mask debt
This is another common narrative I have heard, and it doesn’t accurately portray reality. While there have been notable cases of abuse, the majority of companies using SCF are using it to ensure their supply chain is able to function smoothly. SCF provides access to the finance needed to help businesses within the supply chain, not as a form of obscure lending.
There are rare cases where a third-party finance provider pays suppliers on their contractually agreed payment term, but allows the buyer to make the final repayment later than the agreed term with their suppliers at a higher cost. Most within the industry between auditors, practitioners and others would clearly define this as a loan. It does not represent best practice and does not meet the commonly accepted definition of SCF. SCF is about giving suppliers an option to be paid early.
Myth 4: SCF isn’t a reliable option
This one is particularly interesting considering the experience of the past 18 months. During the global pandemic, we saw an unprecedented shock event for which, understandably, very few had planned. Traditionally, during recessions the largest financial institutions pull lines of finance to reduce their risk exposure.
During this time, we have seen the opposite when it comes to SCF. Across the industry, SCF saw a sharp increase in usage, and the financial institutions that invest in these assets have increased funding to support these higher volumes.
Myth 5: SCF is only about finance
While the financial benefits shouldn’t be minimised, many overlook how SCF is a force for good. SCF can be used as a tool to enhance a company’s environmental, social, and governance (ESG) goals. Through SCF, large businesses can encourage improvements in ESG scores by providing preferential rates to those of its suppliers that perform better in this respect. Companies can also use these programmes to help small and minority-owned businesses grow and thrive. This is a great example of the future of our industry in action.
The potential impact of SCF on businesses large and small around the world is hugely positive. Debunking these myths is a small step along the journey of ensuring more business can benefit from unlocking cash within the supply chain.