Supplier financing, also known as supply chain finance, is a series of financial tools in the manufacturing and supplying industries that eases the relationship between the suppliers of raw materials and products and the companies that want to buy from them.
The reason for supplier financing stems from the fact that buyers and suppliers often run into issues because of the fact that suppliers want to be paid quickly while buyers like to keep money as long as possible to control their cash flow. This especially becomes a problem when buyers have contracts that enable them to wait 60 or more days to pay their invoices. Supplier financing fixes this problem by helping bridge the gap between both sides.
How Does Supplier Financing Work?
Supplier financing is funding that provides financing for transactions between companies and gives suppliers distribution of funds up front. A third party group stands between companies buying materials and the suppliers of those materials. Instead of companies dealing directly with suppliers, they deal with each other through the third party agency, whether it’s a bank or some other financial institution. Buyers order through a supplier finance company which extends a line of credit to the buyer and orders and makes payments for the products. The third party group then pays the supplier upfront and the buyer is invoiced for the amount of the goods bought, along with a service fee. This invoice is then dealt with according to the buyer’s typical commercial terms.
This is beneficial because buyers are able to get their materials while holding onto their money for a longer period of time. This enables them to keep their liquid assets free as long as possible and invest in their future, whether that’s through paying off other bills or expanding the business in other ways.
In addition, suppliers usually offer a discount if invoices are paid at an earlier date and with supplier financing, buyers can take advantage of the discount without disrupting their cash flow, as long as the service fee charged by the third party group does not exceed the discount incurred from early payment.
The supply chain is also stabilized, as the buyer and supplier build more confidence in each other. Buyers can stay flexible and suppliers no longer have to deal with cash flow crunches. This stability is important in any business relationship.
Supplier Financing Isn’t Right for Every Company
Supplier financing is a relatively new resource for businesses, and as such, the guidelines and rules are still frequently changing. Most qualifications to get started currently surround the success and stability of a company. Just like with traditional loans, there are stipulations which have to be met in order to be eligible for the service. The ability to provide financial statements, a minimum number of years of operations (usually two or three) and minimum annual revenues are all types of qualifications that supplier financing providers use to decide whether or not a potential client meets their guidelines.
You Don’t Need A Bank to Get Started
Supplier finance does not need a bank to work. Whatever needs to be done is done solely through the buyer, the supplier, and the third party supplier financing company. Many supplier financing companies are in the business independently. Banks can choose to back up a supply financing program by supplying loans to buyers to pay the supply finance company, but it is not necessary and the supply financing does not need a bank to operate.
Supply Financing is Not Just for Large, Well Established Firms
Many times, small business owners find it difficult to enjoy some of the benefits available for big enterprises, such as the ability to get a loan for investment and expansion. This is largely due to the fact that small businesses tend to have a very high chance of folding within the first few years of operation. However, supplier financing can be a huge benefit for small businesses on account of the cash flow it frees up by allowing buyers to keep their money for a longer period of time and still receive the goods they ordered. Small businesses still need to meet requirements of stability and profitability as mentioned above to be eligible for the services.
Over recent years, supply chain financing has become more prominent and inclusive than ever before. With technological advancements, supply chain financing has become much easier, with online platforms for placing orders and dealing with third parties and sellers, making it possible for smaller business to take part in the benefits of the process.
These online platforms allows buyers to monitor every aspect of the supply chain process.
Are There Any Drawbacks?
Defaulting on payments is not as common with supplier financing because of the strict requirements for businesses to be a part of it. However, should you fail to pay the supplier financing group, the procedure follows that of regular unpaid invoices. Since the bill sent to you for the products is an invoice, failure to pay will be dealt with in the same way as other unpaid invoices. On the bright side, should you fail to pay an invoice on time as a buyer, it will not impact your relationship with the supplier, as they will have already received payment for the items, allowing you return to them for further products regardless of your payment status. Understandably, though, you can’t use the supplier financing company to do this. It’s always a good idea to make sure you’re on time with all your payments to avoid these problems.
Is Supplier Financing Right For Your Business?
Supplier financing is a great option for many businesses, however, it ultimately depends on the products you sell. Many times, building a supply chain is important and supplier financing allows businesses to both stabilize their supply chain and hold onto liquid assets for a longer period of time than would otherwise be possible. In addition, in light of the new technology involved with it, it can increase the efficiency and cost-effectiveness of your business operations. However, it may also not be a good program for your business, depending on your product and your qualifications. At the end of the day, like most different business decisions, it all comes down to what works for your business and your business plan.