Sun | Feb 11, 2024 | 7:47 AM PST

Supply chain finance, sometimes called supplier finance, is an approach to supply chain management in which a supplier receives payments for their invoices early.

Suppose you're a small business owner whose bottom line is impacted heavily by the conditions of your supplier relationships. In that case, you may have heard that supply chain finance can help you optimize your working capital while reducing the risk of supply chain disruption.

Though this is often true, there are a number of potential pitfalls small business owners should be aware of when they decide whether supply chain finance is the right move for them.

In this post, we'll take a closer look at what supply chain finance is, how it might work for your business, and the key risks and benefits you should be aware of when you're considering this financing solution.

How supply chain finance works

Unlike other approaches to finance, supply chain finance is usually initiated by the buyer, with suppliers accessing funds through a third-party provider based on the buyer's credit rating.

This allows suppliers to finance their deliverables at a lower cost than they would with other forms of finance. Giving buyers the freedom to extend their payment terms while still ensuring that their suppliers receive payment.

Supply chain finance begins with buyers entering an agreement with a supply chain finance provider, before asking their supplier(s) to join the program with them.

While some of these programs can be funded by a single bank or other financial institution, it's more common that they're supported by several funders managed through a dedicated third-party finance platform. Supply chain finance provider PrimeRevenue, for example, offers "multibank capability by providing availability to more than 100 financial institutions worldwide."

Traditionally, these programs have only been able to facilitate relationships between a buyer and around 20-50 of their main suppliers. These days, however, technological advances have allowed supply chain finance companies to onboard large numbers of suppliers with ease.

With an agreement in place and both buyer and supplier onboarded on a program, the supply chain finance process is ready to begin. This will typically play out something like this:

Step 1: The buyer initiates a purchase as usual.
Step 2: The supplier will issue an invoice complete with a payment due date.
Step 3: The buyer approves the invoice and the supplier requests an early payment as per the terms of the program.
Step 4: The third-party funder makes the payment to the supplier, minus their fee.
Step 5: The buyer pays the funder no later than the due date on the original invoice.

Benefits and risks of supply chain finance

Supply chain finance can offer a huge boost to logistical efficiency and cash flow optimization for many small businesses. However, adopting this method of managing your supplier finances isn't without its risks.

Here are some of the key benefits and risks to bear in mind when considering supply chain finance.

Supply chain finance benefits

1. It allows you to extend your payment terms as a buyer.

One of the most attractive features of using supply chain finance is that it allows you to extend your payment terms, giving you greater flexibility than you'd have in a regular supply chain relationship.

What's more, supplier finance gives you a unique way to lengthen your payment terms without harming your supplier's cash flow.

2. It strengthens tour relationship with suppliers.

Supply chain finance's various mutual benefits can also be a great way to shore up supplier relationships and remove potential sources of conflict from your work together.

When small businesses can offer their suppliers favorable financing terms they may not have access to otherwise, as well as the option of early payments, this will strengthen their working relationship and the buyer's negotiating position.

3. It gives you greater efficiency.

Modern supply chain finance programs offer fully digitized and intuitive features to handle processes such as invoice validation, invoice payments, financing, and more.

By automating these kinds of routine processes, you can improve the efficiency of routine operations while reducing the chances of disruptive manual errors. This feature can also be an attractive prospect to suppliers as it guarantees a certain standard of quality in inventory management.

4. It allows for greater working capital optimization.

Supply chain finance allows you to strategically change your payment terms in a way that aligns best with your business's unique cash flow cycle. When your payment terms are aligned with your cash flow as neatly as possible, you'll be able to work from a leaner position in terms of your working capital, and reduce the need for excessive inventory holding.

Supply chain finance risks

1. It can increase dependency on suppliers.

Because operating on a supply chain finance basis tends to forge closer relationships between two parties, buyers can fall into the trap of becoming overly dependent on a small number of key suppliers.

This won't be an issue if the supplier keeps operating to a high standard. However, if the supplier runs into issues further down the line, such as financial deficits, production issues, or approving orders they can't fulfill, this could put the buyer in a difficult situation.

2. It can mean greater complexity.

While a standard supplier agreement will usually only involve two parties—the buyer and the supplier—supply chain finance calls for smooth coordination between the buyer, supplier, and whatever financial institution(s) are being leveraged to fund the agreement.

A reliable finance program will be able to streamline the processes of onboarding suppliers, ratifying invoices and accepting card payments. However, you'll still have to manage some of these complexities as a buyer, so be sure to compare card readers and other intuitive payment methods to help streamline your operation.

3. It makes you more susceptible to cybersecurity risks.

Supply chain finance relies heavily on the tech platforms provided by finance programs. Because of this, there's an increased risk that cyberattacks, data leaks, and technical glitches leading to major system failures can upend your supply chain operations.

Though reputable supply chain finance programs will employ robust cybersecurity measures to prevent these things from happening, opting for supply chain finance will mean there's always another entry point for cybersecurity hazards.

The right call for you...

Though it may not be for everyone, opting for supply chain finance as a small business has the potential to revolutionize your operational efficiency and forge a stronger working relationship with your key suppliers.

I hope this overview has given you a greater understanding of supply chain finance, its benefits and risks, and what it can offer for your small business.

To learn more and connect with cybersecurity leaders across the financial sector, attend the SecureWorld Financial Services virtual conference on February 28, 2024. See the agenda and register for free here