Supply Chain Finance Simplified: What, How, and Why

The lack of liquid funds has been a besetting issue for the MSME sector. Small businesses often lack the documentation and collateral required to raise credit from traditional lending institutions, resulting in a perennial lack of working capital. However, supply chain finance has emerged as a potential alternative method by which MSMEs can obtain funding by leveraging their partners and customers. 

Supply chain finance or supplier finance is a form of cash advance; suppliers (MSMEs) can leverage their customers’ higher credit rating in order to raise the necessary funds from lenders. 

Large companies are considered more dependable and therefore have better credit with lending institutions. Therefore, their position in the supply chain allows their suppliers to receive 100% of the approved invoice value advanced from lenders since the risk of non-payment is perceived to be low. 

How does Supply Chain Finance Work?

The supply chain financing process has four simple steps:

1. The supplier sends an invoice to the buyer
2. The buyer confirms to the third-party lender that the invoice has been approved for payment
3. The lender releases funds to the tune of the invoice value (less a small fee)
4. The buyer repays the amount to the lender by the due date.

This gives the supplier MSME immediate access to liquid capital without having to wait out the buyer’s payment cycle. The buyer also receives an extension on the payment. 

Benefits of Supply Chain Finance

Supply chain financing has multiple advantages for both buyers and suppliers. 

• Benefits for buyers:
  • Buyers can extend supply chain payment terms without putting pressure on the suppliers themselves
  • Builds resilience in the supply chain, leading to an uninterrupted supply of the material or product in question
  • Facilitates better business relationships between buyers and suppliers
  • Strong supplier relationships contribute to better business growth.
• Benefits for suppliers:
  • Lower funding costs than traditional credit sources due to buyers’ credit ratings
  • Smooth operations due to access to working capital
  • Stabilized cash flow due to quick payment
  • Improved cashflow forecasting due to clarity on payments and funding
  • Helps build a strong relationship with their customers
  • Better business growth

If leveraged correctly, supply chain finance can help fulfil the MSME sector’s working capital requirements. It helps both buyers and suppliers in different ways, and overall, it helps build strong relationships between corporates, financial institutions, and MSMEs; something crucial to the dream of Atmanirbhar Bharat. 

Sources:

https://m1xchange.com/thought-xchange/supply-chain-finance/ https://www.tatacapital.com/blog/channel-finance/why-supply-chain-financing-is-gaining-traction-and-how-businesses-can-leverage-it/