The Winning M&A Advisor [Vol. 1, Issue 4]
Welcome to the 4th issue of the Winning M&A Advisor, the Axial publication that anonymously unpacks data, fees, and terms…
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Supply chain financing is the process by which buyers and sellers manage their liquidity and cash flows at any link in the supply chain. It is typically based around selling invoices at a discount in order to improve liquidity on either side of the chain. Buyers with strong credit have the most power in supply chain finance.
Supply chain financing has developed significantly since the credit crisis. It was previously viewed as being an option for small to medium-sized business who were in distress, however, an increasing number of healthy businesses, including blue-chip multinationals, are using supply chain financing to build stronger relationships with suppliers, decrease currency risk and ultimately improve liquidity.
There are several major ways that companies can approach their supply chain finance strategy. Here we cover the five most common ways, as well as their pros and cons.
| Type | Pros | Cons |
|---|---|---|
| Factoring: When a supplier sells their accounts receivables at a discount to a financial counterparty in order to get cash today so they can finance part of their ongoing operations. | The counterparty is only evaluating the likelihood that you will get paid, so you often don’t need a credit check. Also, you can get cash in less than 10 days, and often in as little as 1 or 2 days. | Financing costs on factoring can easily exceed 20% of the value of receivables. There are often high minimums on receivables and high late fees, which puts the borrower at risk for lost margins if their customers are late in paying. |
| Trade Credit: A type of credit sellers extend to buyers, allowing the latter to purchase goods from the former without immediate payment. | From the perspective of the creditor, is should induce more sales because purchases can made without the cash. For the buyer, it allows for cash flow freedom and easier response to demand. | If the creditor never gets paid, they will eventually have to write that off as bad debt, which lowers profits. If buyers use a lot of trade credit, they can end up paying more for inventory because sellers often offer discounts for quick payments. |
| Invoice Discounting: When a supplier gets loans from a creditor using discounted accounts receivable, somewhat like factoring, as collateral. | Same pros as factoring, except you manage your own receivables so your buyers will never know that you are cash strapped. | Same cons as factoring. |
| Supplier Subsidies: When a manufacturer uses their own funds to offer lower rate financing options for suppliers, instead of relying on their suppliers to get outside financing. | No financial institutions need to be involved, which allows the manufacturer to issue more credit to suppliers than they would otherwise get and thus ramp up production and revenues. The manufacturer also makes an interest rate on the loaned funds. | This can be risky for the manufacturer, as they are essentially acting as creditors. For example, GE was owed millions in the credit crunch of 2008 and is only now fully recovering. |
| Reverse Factoring: Somewhat like traditional factoring where a supplier gets a loan from an outside financier based on accounts receivable, except that in this case the buyer is committing to pay the creditor on the set date. | As with factoring, the supplier gets immediate cash, however, the buyer has agreed to be ultimately liable and the interest rates are based on the credit of the buyer, and as such are often lower. | Credit availability for the supplier can fluctuate with credit of the buyer. It is also a complicated approval process subject to differing laws in various regulatory jurisdictions. |
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