Supply Chain Finance: An Introduction

Recently, I was speaking with a friend of mine about some of the work he was doing in the finance space. The topic of supply chain finance (SCF) came up. This is a space that I hadn’t spent much time in, so I decided to research it a bit. What I found is really interesting.

Supply chain finance (SCF) has emerged as a critical tool in the global financial landscape. SCF offers a suite of innovative financial solutions to optimize working capital, enhance operational efficiency, and strengthen business resilience. By fostering closer collaboration between buyers, suppliers, and financial institutions, SCF has transformed the way businesses manage their cash flow and navigate the complexities of modern supply chains.

I put together some overview information on the subject and wanted to share in case it is helpful to others.

Financial Benefits: Overview of Unleashing Working Capital Potential

At the core of SCF lies its ability to optimize working capital. SCF is able to provide this benefit by streamlining payment processes and providing access to timely financing that support longer term growth for businesses. Let’s look at the basics of SCF through a hypothetical example (please note all of this is totally made up and only for explanatory purposes).

Say that a firm like GE is going to be building a new washing machine. They wont build all of it themselves. Maybe they will contract out a custom component for it, say the door. They decided on another firm to work with for the door, call them DoorBuilders Co. GE Might say, we need 100,000 doors by December 1st and we will pay you $1M for the doors on March 1st. Great.

Except, DoorBuilders has to pay their employees to build the doors and they have to pay their suppliers for the door parts too and it is going to take time for them to build 100,000 doors (maybe 3 more months or more). Would an employee of DoorBuilders Co be okay working for 6+ months without getting paid. Would a supplier ever sell to the company that doesn’t pay them for 6 months again? In fact it might even mean that suppliers would charge DoorBuilders Co. late fees for missing payments or send them to collections which would hurt the companies credit.

In order to avoid all of this mess, DoorBuilders Co. needs to have cash on hand to finance the 100,000 door purchase order. But if they have a lot of cash on hand then that is bad cash flow management. They could just go to a bank to get a normal loan but they may be a smaller firm and the bank might not cover them or give them really high interest rates.

SCF helps in enhancing cash flow management in this way. SCF facilitates early payment to suppliers, ensuring a steady influx of goods and services without straining the buyer’s financial resources. Once the POs are signed, the supplier is paid the amount (or some portion) and can use that cash immediately to pay their suppliers and employees. This timely payment eliminates the risk of late payment penalties and promotes a more harmonious supplier base.

SCF also often enables businesses to tap into lower financing rates than they could secure independently, leveraging the buyer’s creditworthiness to secure favorable terms. In this case, GE will help DoorBuilders Co access financing through GE (some times even as a part of the business itself). This cost savings directly translates to improved profit margins and enhanced financial stability.

One other sometimes overlooked benefit of SCF, is that it helps foster trust and collaboration between buyers and suppliers. In this case, DoorBuilders Co and GE will work closely together on the financials and operations of their two companies to understand a better picture of eachothers businesses. This helps to strengthen the supply chain relationship between the firms, nurturing a more integrated and efficient supply chain ecosystem. By prioritizing timely payments and open communication, SCF promotes long-term partnerships that benefit all parties involved.

Operational Benefits: Building Resilience and Sustainability

SCF extends its impact beyond financial optimization. SCF also empowers businesses to enhance operational efficiency, navigate unexpected disruptions, and foster sustainable practices.

SCF provides businesses with access to liquidity, enabling them to continue operations even in the face of unforeseen events such as natural disasters or market fluctuations. SCF offers financing options against inventory or receivables, shielding businesses from financial losses arising from demand fluctuations or product recalls.

Say for example, GE has to recall some of their Washing Machines because a part that was developed by another supplier, let’s say a hose, turned out to be faulty. This could be a huge impact to DoorBuilders co if they were financing the development of the doors themselves. However, because of their SCF on the development, they are in a much better financial position to be able to ride out the recall and continue to develop their products and services. This resilience ensures business continuity and protects against financial setbacks.

SCF in High Interest & High Inflation

The current economic climate presents unique challenges for SCF managers. Higher borrowing costs, increased risk of supplier defaults, and evolving supply chains demand careful consideration and strategic adaptation. To effectively navigate these challenges, SCF managers should prioritize supplier selection, negotiate favorable financing terms, and leverage technology to streamline operations and enhance risk management.

Blockchain Technology: Revolutionizing SCF Operations

Saved the best for last. Okay so naturally, I decided to dig in on where blockchain technology could fit in here. The adoption of blockchain technology has had a big impact on supply chains and some impact on SCF. But there is still a lot of opportunity. Blockchain technology in supply chain finance introduces unprecedented levels of transparency, security, and efficiency. By leveraging blockchain’s distributed ledger capabilities, SCF transactions are immutably recorded and traceable, eliminating the risk of fraud or errors.

The visibility provided by blockchain technology enabling businesses to track inventory, monitor payments, and identify potential disruptions proactively. Real-time visibility into the movement of goods and funds throughout the supply chain, in a standardized way that the company can leverage easily has a huge impact on their business. This transparency fosters trust and collaboration among supply chain partners.

Further, blockchain’s decentralized nature ensures that data remains tamper-proof and secure, safeguarding sensitive information from unauthorized access or manipulation. This robust security framework protects businesses from financial losses and reputational damage. Blockchain can also be used to verify the authenticity of documents and data. This can help to improve transparency by making it more difficult to commit fraud or errors.

There are many companies that are building blockchain based technologies for the supply chain. Some of them are larger enterprises like IBM and Maersk launched TradeLens in 2018. TradeLens provides real-time visibility into the movement of goods and documents, enabling businesses to track shipments, reduce errors, and improve decision-making. TradeLens is currently used by a wide range of companies, including major shipping lines, retailers, and manufacturers.

One other area where blockchain offers opportunities for innovation in supply chain financing is through cryptocurrencies and smart contracts. The traditional supply chain finance space operates as most traditional financial institutions do today, via spreadsheets. This is a very slow and time consuming process and often can lead to errors in information used to calculate the critical financing needed for these businesses. Further, the banks that process these loans can take up to 30 days to actually go through all of the documents and ensure the information is correct and accurate. Blockchain based smart contracts and programmatic release for cryptocurrencies or stable coins would greatly help alleviate these tasks.

There are smaller startups and innovative companies that are working to operate in the space and alleviate some of these challenges. Contour is a blockchain-based trade finance platform that allows businesses to digitize their trade documents and connect with financiers. Orda is a blockchain-based platform that provides early payment to suppliers in exchange for a discount on their invoices. Stenn is a fintech company that provides fast and easy access to working capital for small and medium-sized enterprises (SMEs). Velotrade offers alternative financing for suppliers to help bridge the gap between the financing from the banks and when the suppliers need the capital. There are many other lending platforms within the DeFi space that offer loans to individuals and sometimes businesses. But there have not been many that are dedicated to the supply chain financing space.

Conclusion: SCF = A Transformative Force in Business

Supply chain finance has emerged as a transformative force in the global business landscape, empowering businesses to optimize working capital, enhance operational efficiency, and foster sustainable practices. By providing access to liquidity, reducing financing costs, and strengthening supply chain relationships, SCF has revolutionized the way businesses manage their financial resources and navigate the complexities of modern supply chains. Blockchains and distributed ledger technologies offer an ideal means by which to adopt SCF technology. As the world embraces a more interconnected and data-driven economy, SCF is poised to play an increasingly crucial role in driving business success and shaping the future of global commerce.