What is supply chain finance?
Supply chain finance (SCF) is another way to improve an SME’s working capital situation. In contrast to invoice finance, which usually does not rely on the cooperation of the receivables counterparty, supply chain finance is typically initiated by the buyer. Traditional supply chain finance involves a high degree of cooperation and integration between the smaller supplier and the buyer on the other end. With the set-up of a formal supply chain finance programme, suppliers have the ability to opt for the earlier payment of invoices at a discount. The time between this early payment and the invoice eventually being paid by the buyer is typically bridged by a third-party finance provider. The supplier is thus able to raise finance against “approved payables”, which in turn are backed by the credit rating of the company at the head of the supply chain.
SCF remains a very small part of the overall receivables finance market, accounting for less than 4% of global market value (based on figures from the International Factors Group covering 65 countries), but about 12% by value on average in those countries where it is practised at all. According to research by Demica, leading banks are reporting current growth rates of 30–40% per year in SCF volumes. South East Asia, India and China are reportedly the regions with the highest growth potential for supply chain finance providers.
The FinTech solution
Traditional supply chain finance programmes typically involve complex legal frameworks and have only been efficient to operate at larger scale. A modern FinTech supply chain finance solution offers the advantage of being efficient even at a lower scale, making working capital accessible to the entire supply chain. The buyer first needs to connect the enterprise resource planning (ERP) system to that of the supply chain finance provider. The degree of integration between buyer and supplier is flexible and can be set according to the supplier’s requirements. Small suppliers can upload invoices directly to the SCF portal or send their invoices through accounting software, such as Xero. Sophisticated suppliers can integrate their ERP systems to streamline the process further.
Benefits for SMEs
Small businesses benefit from the cheaper cost of working capital relying on the typically superior creditworthiness of their large customer. The large customer is able to optimize its own working capital position by extending its payment terms to 90 days and beyond without putting undue financial pressure on its SME supplier base. Supplier relationships are strengthened because the suppliers no longer have to work with a separate receivables factoring firm; they can use the same integrated platform they use for e-invoicing and self-services.
In terms of small business financing, this is an entirely new model of dynamic credit scoring. This is thanks to the proliferation of mobile payments in China and South East Asia. Due to the volume of transactions, a traditionally underserved market can be confidently served by vendors who can use mobile transaction activity as an indicator for credit scoring.
Large corporates often have vast amounts of cash reserves that lie dormant at low-yielding bank accounts or money-market funds. Nevertheless, more than half of small businesses wait between one and two months to be paid – as buyers have little incentive to pay early. In the dynamic discounting model, the SMEs choose the timing of the payment at their discretion, but the earlier, the higher the discount. In other words, if a seller chooses to be paid 30 days earlier at a discount of 1-2%, the large corporations can over the course of the year make a double-digit return on the funds employed – potentially a more attractive use of a company’s funds.
Supply chain finance in FinTech is still a niche yet growing market. Given the vast number of application cases, this financial product is expected to gain more traction soon, moving to other markets outside the United States such as South East Asia.
Youtap has already moved to capitalise on this opportunity to assist both suppliers and SMEs. We believe that the technology, connectivity and customer awareness are now in place to fully utilise this solution.