Supply chain finance (SCF) is a working capital financing solution designed to create a symbiotic commercial relationship by optimising cashflow for a supplier, while facilitating profitability and supply-chain stability advantages for the buyer. James Gillibrand, director at Kroll, comments
When comparing SCF to alternative working capital financing, such as invoice finance, SCF looks in the opposite direction down the supply chain and provides a financing option to the buyer to increase supplier invoice payments.
While still invoice finance, a lender usually spreads the credit risk over several debtors, whereas the SCF provider is concentrating its finance on one entity with the strength of its balance sheet alone supporting the debt. This means SCF offerings are largely exclusively available to large and multinational corporations.
Prima facie, SCF brings significant benefits to all parties; however, as with many types of finance product, these benefits have equivalent quid pro quos, especially for the supplier.
What are the benefits of SCF compared with invoice finance for the supplier?
SCF ordinarily provides a superior level of funding against specific invoices, resulting in payment against the supplier’s entire invoice value, minus a fee. Typically, an invoice finance facility will advance in the region of 80% of the invoice value, with the balance becoming available to the supplier when the customer pays. In addition, invoice finance facilities often include contractual terms such as concentration limits that could further restrict funding.
SCF facilitates the acceleration of customer receipts and therefore reduces the supplier’s credit control and administrative burden.
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SCF reduces the supplier’s reliance on alternative forms of finance, and in turn reduces the supplier’s financial leverage risk. This reduction in third-party borrowings can also have supplementary benefits such as lower director personal guarantee requirements.
James Gillibrand, Director, Kroll
While an SCF should accelerate payments, in our experience there can be some financial disadvantages and practical challenges for the supplier:
When using SCF, the supplier is not in control of the invoice certification process, which involves the buyer approving the invoice for payment – this can typically take around a week or longer.
While a SCF facility can provide cash flow benefits – as close to 100% of the supplier’s invoice is paid – this can leave the buyer eligible for early payment discounts that can eat into suppliers’ margins.
An invoice finance provider will offer a minimum commitment term to suppliers, whereas an SCF facility can be withdrawn with little notice to the suppliers as the lending relationship is between the buyer and the lender. If the buyer has its SCF facility withdrawn, the supplier could seek to discount the invoices with its own invoice finance provider, but this will typically see a reduction in funding and a potential risk of ‘double funding’ for the lenders.
One of the more controversial traits of SCF is that the lending capital does not have to be declared as debt. This type of accounting can be optically problematic, and something of a grey area. In the case of Carillion, shortly prior to its collapse in 2018, up to £500m ($688m) of debt due to its SCF lender was categorised as trade payables, whereas loans and overdrafts on the balance sheet were reported in the region of only £150m.
It is arguable that this accounting treatment papered over the cracks of Carillion’s true overall debt levels and understated its gearing, in turn enhancing the appearance of Carillion’s balance sheet as more financially appealing.
In the aftermath of Carillion’s downfall it was disclosed that payment terms with its suppliers were an average of 120 days – these were also the terms on which the SCF lender was repaid. In December 2017, Carillion’s SCF facility was withdrawn. The liquidity effect for Carillion and its supply chain was disastrous, resulting in the almost immediate failure of the construction company and terminal collateral damage through its network of suppliers.
Unfortunately, the case of Carillion is just one example; a number of similar failures have brought the subject of SCF regulation under scrutiny. It is widely reported that the accounting treatment ought to be revised, given the debt-like features of SCF, to report the true nature of the borrower’s indebtedness.
As access to SCF is diverse through digitisation and fintechs, there have also been pleas for a wider consistency of SCF lending across the board.
The economic effects of Covid-19 have seen demand for SCF reach new heights to combat liquidity contraction. With SCF seemingly becoming more popular, this may be a symptom of management teams prioritising cashflow headroom over short-term profit; however, SCF may be being used as a sticking plaster where more acute structural challenges exist.
An SCF facility can only be a success if lenders and borrowers are financially buoyant and work in transparent co-operation. Covid-19 has left a damaging imprint on many of the strongest of pre-pandemic debtor covenants, and as the ongoing economic uncertainty continues, the lasting longer-term impact on the users and purveyors of SCF remains unclear.
With an uptick in SCF demand at a time when economic uncertainty refuses to wither away, it is important for businesses involved in SCF to consider the financial ramifications if the fragile business chain were to break.