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Discovering and Unleashing The Financing Potential To Grow Supply Chains in Cross-Border Trade
May 1, 2019
By Peter Nunes
As Julie Andrews once famously sang: “Let’s start at the very beginning…” So, what exactly is trade? Merriam-Webster defines trade as “to engage in the exchange, purchase or sale of goods.” Sounds simple enough — I buy grapes from a California grower and sell them to Publix Supermarkets in Florida where I live. Now if I decided to diversify my business and sell wagyu beef from Nebraska to be sold to supermarket chains in China, I have now entered the inextricably more complicated world of cross-border trade. Both domestic and cross-border trade have common elements: there may not be synchronicity in supplier and buyer payment terms creating a cash crunch; goods have to be transported from supplier to buyer and be insured; there is the risk of product dispute and non-acceptance by the buyer and, of course, your buyer may not pay you. Now imagine having to deal with these very same issues — only now your Shanghai-based buyer is in a time zone that is 12 hours ahead of you and does not speak fluent English.
A lender also has to deal with a lot of cross-border inefficiencies due to buyer-seller miscommunication, paper documents such as bills of lading and inspection certificates arriving by snail mail; and acceptance-of-goods issues by the buyer. Many U.S. lenders factor foreign receivables, provided credit insurance can be raised on the buyers and, indeed, for some of these lenders, their foreign end-debtor portfolio can sometimes exceed 50% of their entire portfolio. But there is a market disrupter already afoot in the factoring space and one which can present a great opportunity for a lender to grow both its domestic and foreign assets under management. This is supply chain finance (SCF), also known as reverse factoring.
Depending on whom you talk to, the definition for SCF varies. From a bank perspective, the most likely answer will be: financing provided to suppliers by a financial institution based on confirmed invoices by a creditworthy buyer. From a corporate buyer’s perspective, it is a means to extend payment terms with their suppliers to reduce their company’s working capital challenges. What they both refer to is reverse factoring (RF)/supplier finance. If you zoom out a little, SCF is about instruments to finance the supply chain. From an even broader perspective, it can be interpreted as optimizing cash flows and capital allocation in the supply chain via supply chain integration (processes) and collaboration (relationship) to create value for the entire chain, as well as for all the individual partners.
This seamless integration of processes (secure payment processing, connecting global suppliers for U.S. buyers and factors, onboarding) and relationships (buyer, seller and lender) can only be facilitated by an SCF platform. Working together in a more transparent way by using platform technology will eliminate the information asymmetry that exists today and the associated costs and risks.
The basis for SCF is the underlying transaction between the buyer and the supplier. The invoice for the transaction is submitted along with all those snail mail documents (which are now digitized) on the SCF platform to the buyer by the supplier. Electronic communication between the supplier and buyer is supported by the platform. As soon as the buyer has approved the invoice/account payable, the approval is communicated via the SCF platform allowing the supplier and lender to see it. The buyer approves the invoice and requests finance from the lender. The lender receives this request via the SCF platform and pays the supplier for the invoice, withholding the agreed discount. When the agreed payment term expires, the buyer makes a payment to the lender, after which all obligations have been met.
Reverse factoring reduces costs across the supply chain by letting suppliers “borrow” against their customers’ creditworthiness instead of their own. On average, 80% of the resulting value is shared between the suppliers and the buyer, with varying degrees of allocation depending on whether the buyer wants to facilitate its key suppliers’ financials (i.e. the largest share goes to supplier) or, instead, take all the benefits by extending payment terms. Typically, the buyer will capture 35% to 50% of all savings, while suppliers will get 25% to 45%. Another 15% goes to the financial intermediary while the remaining 5% is for the service provider.
Growth in assets under management for the lender derives from the fact that their current factoring workflow can also be used for SCF with minimal workflow changes for the lender and increased scalability. In a closed user group ecosystem, a lender can layer on more business by engaging and enabling many suppliers to a single credit worthy buyer. This creates many cross-selling opportunities for the lender up and down the various nodes of the supply chain. TSL
ACCA – A study of the Business Case for Supply Chain Finance
The Paypers – B2B Payments, Supply Chain Finance & E-Invoicing market Guide 2015
The Vayana Network.