Supply chain finance is often described as “the set of solutions available for financing specific goods and/or products as they move from origin to destination along the supply chain.” Clear as crystal, right? Supply chain finance is certainly more complicated than this definition, which leaves us with nothing but questions. What exactly are the set of solutions available? Who provides these solutions? What rules govern the movement of goods, and what are the risks involved?
Supply chain finance entails many separate, yet inter-related solutions provided by traditional and nontraditional finance sources. There are many risks along the way, and the rulebook that governs the movement of goods, the risk of loss and transfer of title is very complicated. Not all supply chain finance solutions fit all situations, and not all supply chain finance providers have the same skill set or risk appetite to provide a one-stop-shop to those businesses involved in international trade. It is important to not only understand what supply chain finance is, and the associated risks, but to align with providers who understand these critical issues and can efficiently and safely provide the best supply chain finance solution.
A Global Playing Field
We live in a global market. Globalization allows all parties to benefit from each other’s comparative advantage. Globalization and offshore production have also lengthened trade cycles. As a result, many companies have experienced a reduction in capital availability. All parties in the supply chain are under pressure as they jockey to improve their own cash flow. Improving one company’s cash flow often comes at the expense of another’s, especially when overseas suppliers require upfront deposits, or importers require extended payment terms from their overseas suppliers. While this problem is not isolated to international trade, it occurs more often with importers and exporters since there are longer trade cycles, different currencies and cultural dynamics involved. At the end of the day, the goal of an effective supply chain finance solution is to combine timely and accurate information, and to control the logistics over goods to help mitigate financial risk. Doing so enables companies to raise more capital, gain access to capital sooner and lower the cost of financing.
Supply chain finance solutions such as credit insurance, government-backed working capital guaranty programs, receivables financing, reverse factoring, letters of credit, documentary collections and purchase order financing are designed to help relieve the cash flow gaps that exist in trade. Not all solutions work in the same manner or provide the same benefits. Understanding the differences is critical.
Common Cash-Flow Challenges
Let’s examine some of the common cash-flow challenges many companies face when managing their supply chain. For illustration purposes, importers will be the focus, however, many of the same challenges apply to all parties in the supply chain.
First, delivery lead times to end customers can be 90 days or longer. Any production delays or quality issues can further extend lead times, which can adversely affect businesses with seasonal demand. Second, goods must be properly insured at the point where risk of loss transfers from the overseas supplier to the importer. Goods in-transit must be tracked very closely to ensure there are no delays with freight bookings, customs clearance and warehousing. Supplier, insurance and logistics costs must be arranged and paid well before repayment from the ultimate end customer is received. Supplier credit can only sustain the cash-flow gap that exists for so long a period, especially when end customers require extended payment terms from the U.S. importer.
Supply chain finance solutions such as receivables financing (factoring and asset based lending) can help accelerate cash flow once goods have been delivered to the end customer. However, receivables financing doesn’t provide a solution when overseas suppliers demand cash payment or an irrevocable payment instrument prior to production or shipping. In-transit inventory financing can help shorten the cash-flow gap. However, advance rates typically do not cover the full cost of goods. In-transit inventory financing can’t be used until goods have been produced and shipped. In-transit inventory financing is also very risky for lenders since unpaid overseas suppliers can directly affect the lender’s security interest. Unless suppliers are willing to produce and extend credit to a certain point within the supply chain so inventory and/or accounts receivable financing can be utilized to accelerate cash flow, an additional supply chain solution will be needed. That solution is purchase order funding.
A Tailored Solution
Unlike accounts receivable financing, purchase order funding provides availability much earlier in the supply chain to cover up to 100% of the cost of goods including logistics and, in some cases, direct labor costs. Purchase order funding focuses on the terms of the orders and/or contracts issued by the ultimate end customer and provides a tailored solution to successfully fulfill deliveries on time. Purchase order funding enables companies to issue letters of credit and credit guaranties and make cash payments to secure payment to domestic and overseas suppliers prior to the production and shipment of goods. This is significantly different than the solutions provided by accounts receivable and in-transit inventory financing since purchase order funding can be utilized at the beginning of the supply chain. Purchase order funding provides a more flexible solution by focusing on the credit of the end customers and terms of sale rather than solely on the balance sheet of the company looking for financing.
An experienced purchase order funding company not only provides a funding solution at the onset of the supply chain, but also helps implement a structure and best practices to ensure quality goods are delivered to end customers on time. Requirements such as thirdparty inspections, import and in-transit documentation, insurance and inventory control during transit helps ensure goods are delivered on time to fulfill critical deliveries to valued end customers. Once goods have been produced, shipped and invoiced to the ultimate end customer, accounts receivable financing can be utilized to help further accelerate the cash flow needs to keep the supply chain moving. With the help of purchase order financing, in addition to other supply chain solutions like accounts receivable financing, companies now have a solution that not only provides adequate capital along the supply chain, but also offers the advantage of managing pre-shipment and in-transit risk by enlisting experienced professionals.