Why Supply Chain Finance is an Important Risk Mitigation Tool

 

The trade finance landscape has evolved dramatically, creating a change in customer needs and developing an appetite to change the way the industry operates. Businesses have now started preferring Supply Chain Finance (SCF) solutions, after decades of dependency on traditional finance from banks, which are costly and have rather lengthy procedures.

Additionally, as global trade is increasing through open account terms, traditional methods of trade finance, such as Letters of Credit are decreasing. This is happening at the same time that new market players and intensified competition in global trade have increased the demand for flexible payment terms, shifting the focus to open account terms, where goods are delivered weeks or months before payment is due. At present, open account transactions represent more than 80% of trade, and are considered quite important to facilitate international trade growth and the continued expansion of supply chain finance.

Considering the fact that 70% of MSMEs in the emerging markets lack access to credit, supply chain finance has the potential to be one of the best solutions for accessing credit and cash flow.

The term supply chain finance covers different approaches to extending credit, such as reverse factoring, in which a company arranges financing based on invoices from suppliers that it has approved for payment, or dynamic discounting, in which the company offers to pay the supplier early at a discounted rate. As per the World Supply Chain Finance Report 2018 produced by BCR Publishing Ltd, supply chain finance has increased by 36% year-on-year in 2016 to hit US$447.8 billion, and it is clearly evident that companies have now begun to consider supply chain finance as a tool that reduces cost and optimizes liquidity and working capital.

As businesses operate in a high-risk and trade-intensive environment, SCF is widely acknowledged as a means of reducing the risks involved in their supply chains. In the current regulatory environment, most banks and finance providers continue to struggle to onboard buyers and suppliers. By understanding the various risks involved in the supply chain, non-bank SCF finance providers can offer tailored, efficient, effective risk-reduction supply chain finance solutions.

Supply chain finance provides a strong mitigation tool that can handle a great many supply chain risks. SCF is widely accepted as a means of reducing the risk of supplier failure by enabling suppliers to get early access to liquidity and SCF is an even more powerful tool for mitigating the disruption risks faced by suppliers due to natural disasters or supplier insolvency, by making working capital readily available for them to get them back on their feet quickly.

Sometimes, businesses face risks due to delays, which can be mitigated by giving them access to an SCF program, and allowing them to increase their responsiveness and reduce supply delays. Suppliers also face forecast risk, which can be reduced by SCF programs, as it reduces the credit risk and payment uncertainty surrounding receivables.

Supply chain finance models such as reverse factoring can be an excellent way of fostering loyalty among the supply base, which goes some way to mitigating against supplier price hikes and procurement risk. SCF helps reduce the risk of non-payment, also known as receivables risk, as SCF creates a discipline on the part of the buyers, because the buyers need to pay the bank or the finance provider, rather than their suppliers.

It is clear that many of the risks discussed above are related and heavily intertwined, and that supply chain finance is the ideal tool for addressing these risks, by providing financial support, building supplier loyalty, reducing physical supply chain risks and the cost volatility that goes with it. Thus supply chain finance is not just a working capital and liquidity solution, but a strong risk mitigation tool as well.