Trade relationships can be problematic for one main reason – both suppliers and buyers are motivated by two opposing forces when it comes to cash flow management. Suppliers seek to be paid as soon as goods and services are delivered, while buyers seek to delay payment.
As a result of their increased purchasing power, many larger buyers are able to delay payment by dictating payment terms beyond a supplier’s working capital comfort zone. Small buyers, on the other hand, can be just as problematic and are renowned for letting unpaid invoices fall overdue.
When suppliers themselves are buyers, which is often the case in a multitude of industries, one large contract with a large corporate buyer on 60-day terms can severely impact their ability to pay their own suppliers on 15 or 30-day terms. Once overdue payments are factored in, then it should come as no surprise that a lack of cash flow is the leading cause of small business insolvency.
And as global supply chains become more and more prevalent, factoring in time delays associated with slower cross-border transactions is also something suppliers must contend with.
When revenues aren’t consistent enough to support long periods without payment, then faced with the predicament of needing to keep the lights on and make payroll, suppliers will often look to source capital from elsewhere as an interim business prop.
Traditional products from banks and non-bank lenders, like business overdrafts, short-term unsecured business loans or even a line of credit tend to be the traditional default for many.
Yet like most defaults, they can also be the most expensive and the least flexible option. A line of credit is a typical example. Many businesses are forced into paying an annual or monthly fee for access to temporary debt they may only need to tap into 2 or 3 times per year.
The key to resolving the bottleneck in liquidity is to rethink the financial relationship between suppliers and buyers. This means acknowledging both of their opposing desires; suppliers who seek ‘as soon as possible’ payment, and buyers who want ‘as late as possible’ payment.
With the help of a financial intermediary, it is possible to design a system that satisfies both needs, yet still keeps the relationship between supplier and buyer intact.
This system is called supply chain finance, and thanks to technology, is now one of the fastest growing types of finance in the world. While related to in part to invoice discounting and factoring, supply chain finance does not involve the sale of an invoice to a third party.
In essence, it is the extension of a buyer’s accounts payable function and the introduction of a funding partner into the buyer-supplier relationship.
1. A supplier issues an invoice to a buyer, as per normal.
2. The buyer approves the invoice.
3. On approval, a funding arm linked to the buyer is notified the invoice has been approved. This may be through a direct integration into the buyers accounts management system, or an upload into the funder’s online platform. To get a sense for how this works with a real world example, see how the Octet platform works.
4. The supplier, who also has access to the platform is able to track all approved invoices. They can then request early payment on any invoice.
5. If early payment is requested, the funder automatically issues payment to the supplier, minus a small fee. Settlement is often as early as the next business day.
On the original invoice due date, the buyer issues payment to the funder, completing the loop.
When suppliers are forced to plug working capital gaps with loans, they must rely on their own credit rating and liquid assets to secure the facility. For small businesses, this can be difficult, often forcing them into non-commercial terms with lenders.
With supply chain finance, because the buyer is responsible for establishing the facility, the supplier can in effect piggyback on their credit rating, and avoid establishing their own facility altogether.
If the buyer is significantly larger and more powerful from a negotiation standpoint than the supplier, then they will be able to negotiate access to debt on far more favourable terms.
This is a great win-win.
You might be wondering why a buyer would consider wearing the cost of supply chain finance, rather than simply letting small suppliers battle with the downstream effects of their delayed payments.
There are a number of reasons why, and not just the damage to the relationship that is caused when a buyer puts a supplier under cash flow pressure.
The reality is, when a supplier is forced into a situation where overheads are increasing due to expensive working capital facilities, this will feed through into their pricing, hurting buyers in the long term.
In addition, being able to delay payment by leveraging the funder at the heart of the system also improves working capital management and allocation for the buyer, helping them get a return on their investment in the facility in other less direct ways.
If you would like to learn more about how Octet is helping a global community of buyers and suppliers tap into the benefits of supply chain finance, contact our team of professionals today.