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What is Supply Chain Finance
Supply chain finance (SCF) is a term describing a set of technology-based solutions that aim to lower financing costs and improve business efficiency for buyers and sellers linked in a sales transaction. It is generally defined as ‘an arrangement whereby a buyer agrees to approve his suppliers’ invoices for financing by a bank or other financier’- often referred to as “factors.”
SCF is a solution designed to benefit both suppliers and buyers; suppliers get paid early and buyers can extend their payment terms. This solution allows businesses which import goods to unlock working capital as well as reduce the risk associated with buying goods in bulk and/or transporting them globally.
SCF methodologies work by automating transactions and tracking invoice approval and settlement processes, from initiation to completion.
The current economic climate is forcing many companies to better manage liquidity. Supply Chain Finance can be an attractive way for companies to improve their working capital position whilst also having a positive impact on EBIT.
Understanding the dynamics and complexities of international trade is important for buyers, sellers and lenders. Managing risks is key to growing a successful trading business, either internationally or domestically. This can be done by using specific types and structures of trade finance products. International trade carries substantially more risks than domestic transactions, due to differences in language, culture, politics, legislation and currency. We have thus summarized the main types of risk under the headings below: product, manufacturing, transport and currency.
Product risks are risks that the seller automatically has to accept as an integral part of their commitment. First, it is a matter of the product itself, or the agreed delivery; for example, specified performance warranties or agreed maintenance or service obligations
The buyer must consider how external factors such as how negligence during production, or extreme weather during shipping could affect their product. These matters could lead to disputes between the parties, even after contracts are signed.
It is therefore important for the seller that the contract is worded correctly, so that any changes which could affect the product are covered, with clear outcomes provided.
Manufacturing risks are particularly common for products which are tailor-made or have unique specifications. Often, the seller would be required to cover costs of any readjustments of the product until the buyer sees fit, because the product cannot be resold to other buyers. Such risks can be addressed as early as the product planning phase, which often means the buyer has to enter payment obligations at a much earlier stage of the transaction.
These are the risks associated with the movement of the goods from the seller to the buyer. Cargo and transport risks can be reduced through cargo insurance, which is usually defined by standard international policy wordings (issued by the Institute of London Underwriters or the American Institute of Marine Underwriters).
It should however be noted that the agreed terms of delivery will usually state who is responsible for arranging insurance (the buyer or seller).
If the buyer fails to insure (where it is his responsibility) the cargo shipment in a proper way, the insurance could be invalid if, for example, the port or transport route changes and the items arrive in damaged condition.
Currency Risks
Currency risk management is often misunderstood or neglected by businesses. Any business which purchases and sells products (or services) in multiple currencies should consider options to mitigate foreign exchange (FX) rate volatility.
Changes in exchange rates will impact the profit margin on international contracts, as well as the value of any assets, liabilities and cash flows which are denominated in a foreign currency. It is thus noteworthy to state that there are ranges of financial instruments available to manage FX risk. Due to the increasing volatility seen in the market and the need to operate in various currencies, policies need to be flexible and catered accordingly. Hence, various strategies can be used to manage currency risk. This usually involve using spot contracts, options, and forwards.
Prior to developing a strategy, a company should consider the following:
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