We recently looked at invoice discounting as a way of dealing with short-term cashflow and liquidity issues.

But it’s not the only way of providing short-term liquidity to fend off the wolves at your door. There is another method of finance that will not only help you with cash flow but also assist with bolstering your supply chain against the impact of EU exit now that we find ourselves in a period of transition leading up to Brexit after 31 December 2020.

It’s one among many tools in the finance box to help your business.

Download our guide to finding for SMEs for more on other sources of finance

• What is Supply Chain Finance?
• How does Supply Chain Finance work?
• Why use Supply Chain Finance?
• Stocking up for Brexit
• How Supply Chain Finance differs

What is Supply Chain Finance?

Supply Chain Finance is a relatively new way of providing liquidity to businesses. Traditionally, businesses have used short-term trading assets such as stock or receivables as security to access working capital finance. From a lenders point of view the accounts receivable ledger is the most attractive way of securing the loan and their repayment source is the collection of these accounts receivable from your end customer.

Invoice discounting looks up the supply chain to your customers and use their debts as security. Supply Chain Finance, on the other hand, looks down the supply chain to your suppliers. It is a form of working capital finance which provides liquidity in a similar way to an overdraft, but the funds are only used to pay suppliers.

Supply Chain Finance improves your cash flow by allowing you to lengthen your payment terms to your suppliers while providing the option for your large and SME suppliers to get paid early. This results in a win-win situation for the buyer and supplier. The buyer optimises working capital and the supplier generates additional operating cash flow, thus minimising risk across the supply chain.

How does Supply Chain Finance work?

Supply Chain Finance is an unsecured, revolving working capital facility that sits off your balance sheet. The lender pays for stock purchases directly for the buyer, without affecting existing banking lines or security. The facility is then repaid by the buyer at a pre-arranged future date; usually at the end of the trade cycle when debtor funds are received.

There are two main types of Supply Chain Finance, based on which party initiates the finance:

• Supplier initiated
• Buyer initiated

Supplier initiated programmes (including reverse factoring) allow suppliers to request early payment on approved invoices before they are due. The supplier receives the early payment from the lender (less the finance fee) and the lender gets repaid by the borrower on the due date.

Buyer initiated programmes (sometimes called purchase finance or supplier finance) involve the buyer instructing the lender to make payments directly to the supplier. These payments can be made early or on the due date. The fee is usually charged to the buyer who repays the lender on the agreed date (may be after the due date).

Why use Supply Chain Finance?

Not all companies will use Supply Chain Finance for the sole benefit of their suppliers or to secure their supply chain. EU exit has changed that. Up until recently common reasons to use Supply Chain Finance have included:

• The buyer requires additional working capital to fund growth (or manage seasonal cycles), Supply Chain Finance can provide a valuable source of new liquidity, enabling the borrower to increase their sales.
• Some buyers choose to improve their own balance sheet by extending supplier payment terms before offering Supply Chain Finance (see reverse factoring below).
• In supply chains where the supplier struggles to access finance (or finance is expensive compared to the buyer) both parties can benefit from this credit arbitrage by sharing the savings.
• Where shortages exist, buyers can gain an advantage by using Supply Chain Finance to attract the best suppliers without impacting their own working capital.

Stocking up for Brexit

Since 31 January 2020 the UK has been in a transition period in preparation for finally leaving the EU on 1 January 2021.

There is plenty of anecdotal evidence that UK businesses are stockpiling goods and increasing inventories, particularly in the wholesale, food and drink, medical and manufacturing sectors.

It’s important to remember that although stockpiling and boosting inventories may resolve some of your issues; it can also create others. You need to plan ahead to ensure that you remain flexible enough to be able to adapt quickly to any emerging challenges in your market sector. The important question to ask yourself is: how much additional stock should I purchase and how will it be financed?

Using your cash reserves to buy stock will impact your cashflow by making your business less liquid and tying up your working capital. If you buy stock using credit, then Supply Chain Finance may be the ideal solution for you.

This solution allows you to make additional stock purchases without using valuable cashflow. It can also bridge funding gaps between payment of suppliers and inward payments received from customers. The facility also extends creditor terms which means stock purchases can be spread out over a longer term (without any detriment to the supplier). This acts as a working capital injection which can be used to fuel future business growth.

How Supply Chain Finance differs from other sources of finance

Supply Chain Finance (SCF) solutions differ from traditional supply chain programs to enhance working capital, such as factoring and payment discounts, in two ways:

• SCF connects financial transactions to value as it moves through the supply chain.
• SCF encourages collaboration between the buyer and seller, rather than the competition that often pits buyer against seller and vice versa.

Often a buyer will try and delay payment, but the seller will seek to be paid as soon as possible. SCF works especially well when the buyer has a better credit rating than the seller and can therefore access capital at a lower cost. The buyer can use this advantage to negotiate better terms from the seller such as an extension of payment terms, which enables the buyer to conserve cash or use it for other purposes. The seller benefits by accessing cheaper capital, while having the option to sell its receivables to receive immediate payment.

A buyer using SCF can mitigate the impact of term extension on their suppliers and take cost out of the supply chain. It improves the supplier’s cash flow and provides the option to accelerate the collection of their trade receivables.

To find out how Pegasus funding can help with your Supply Chain Finance and preparing for Brexit please contact one of our expert advisors on 0203 327 0567 or email [email protected].