Supply chain finance (SCF), also known as supplier finance or reverse factoring, comprises a suite of financial solutions that aim to manage working capital and liquidity for businesses within a supply chain. These arrangements are typically initiated by a buyer to allow their suppliers to access funding for their accounts receivable at interest rates based on the buyer's credit rating, which is often lower than the supplier's own cost of capital. The process is intended to provide financial stability to the supply chain by reducing costs for the participating parties. A 2015 report estimated that SCF had a potential global revenue pool of $20 billion. Reverse factoring differs from traditional factoring, where a supplier independently seeks to finance its receivables through a third party. As of 2011, the reverse factoring market was estimated to represent less than 3% of the total global factoring market. The technique has also been associated with financial controversy; for example, it was utilized in schemes that contributed to the collapse of the Evergrande Group, China's second-largest real estate company.
Method The reverse factoring method, still rare, is similar to the factoring insofar as it involves three actors: the ordering party (customer), the supplier, and the factor. Just as with basic factoring, the aim of the process is to finance the supplier's receivables by a financier (the factor), so the supplier can cash in the money for what they sold immediately (minus any interest the factor deducts to finance the advance of money). Unlike basic factoring, the initiative does not come from the supplier who would have presented invoices to the factor to be paid earlier. With supply chain finance, it is the ordering party (customer) who initiates the process – usually a large company – choosing invoices that they will allow to be paid earlier by the factor. And then, the supplier will themselves choose which of these invoices he will need to be paid by the factor. It is therefore a collaborative initiative involving the ordering party, the supplier and the factor. Because it is the ordering party that starts the process, it is their liability that is engaged, and therefore the interest applied to the deduction is lower than the one the supplier would have been given had they done it on their own. The ordering party will then benefit from part of the benefit realized by the factor, because they are the one allowing this. The financier, for their part, will make their profit and create a durable relationship with both the supplier and the ordering party. Reverse factoring can be used by companies outsourcing a large volume of services (e.g. clinical research activities by pharmaceutical companies). The benefit to both parties is that the company providing the services can receive payment within 10 days or less, compared to the normal 30 to 45 day payment terms, while the ordering party can delay actual payment by 120 to 180 days, thereby improving cash flow. The cost of financing is typically a set interest rate tied to a market index plus a basis points adjustment.
Concept To understand how reverse factoring works, one needs to be familiar with trade discounts and factoring. Reverse factoring can be considered a combination of these two methods, taking advantages of both in order to redistribute the benefits to all three actors. There are 8 individual aspects of those three financing methods:
History The concept of reverse factoring started with automobile constructors, including Fiat in the 1980s, who used this kind of financing process for its suppliers in order to realise a better margin. The principle then spread to the retail industry because of the interest it represents for a sector where payment delays are at the heart of every negotiation. In the 1990s and early 2000s, reverse factoring was not used extensively due to economic conditions that did not allow it to be an efficient method of financing. Aberdeen Group research published in 2006 highlighted the central role of a technology platform in realising a supply chain finance solution, defining it as a combination of trade finance functions and technology platforms. A Demica research report published in 2007 noted that businesses in the Nordic region, especially Sweden, made more extensive use of supply chain finance than elsewhere in Europe. In September 2009 the Bank of England invited relevant UK financial bodies to establish a working group in order to review the supply chain finance market at that time. The working group was chaired by the Association of Corporate Treasurers. The group was asked in particular to look at whether there was potential for the SCF market to be expanded, what impediments affected potential expansion, and how the various examples of SCF programmes operated. On the various programmes, the working group argued that "no one structure should be singled out as the preferred option", but concluded that for small and medium sized enterprises and/or companies with a weaker credit standing, buyer-driven SCF programmes, also referred to as "buyer driven receivables programmes", could ease access to credit on terms which were beneficial both to the suppliers and their commercial customers. In 2021, the second largest Chinese real estate company, Evergrande Group defaulted. It had used retail financial investments to plug its funding gaps, raising billions of US dollars through wealth management products to repay other wealth product investors. The products sold were highly risky. Referred to as a type of "supply chain finance", investors would invest money in shell companies which they falsely believed existed to supplement working capital. As sales of the products fell, their business model became unsustainable.
Advantages
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