Supply chain finance is gaining prominence as an important financial tool for the supply chain. Today’s world of globalization has spawned a number of innovations because organizations do business globally. Supply chain finance is one of the modernisms that have come up to expedite the flow of trade across national borders.
Basically, supply chain finance is a set of processes concerning business and finance. It is a technology-driven chain of processes that links the different cogs in the wheel of a transaction. These cogs could consist of all the players involved in the transaction, such as the buyer, the seller and the financial institution which has financed either the seller or buyer, or both. Supply chain finance works with these different, but related players together with the aim of easing the burden associated with credit financing, on which most supply chain businesses run.
How does supply chain finance work?
We have to understand that supply chain finance is offered by the financial institution with whom any of the entities involved in a global exchange of transactions work. Typically, most organizations that trade globally would work with financial institutions. What these financial institutions do is to lend money in some circumstances at the behest of the buyer. An imaginary example would help illustrate this better:
- Let us say Company X is in the habit of buying goods from Supplier Y
- Supplier Y supplies certain goods to X and submits it an invoice. X, which has initiated the deal, approves the invoice for payment for the regular period, say, 60 days
- For some reason, Y is need of some urgent money. This can happen in any business in any situation, and is nothing unusual. Y requests payment for the invoice it has raised with X and seeks a quicker payment. Since X is not prepared for this request and is not having the necessary money, what it does is to approach its financial institution, Z to expedite this particular invoice.
- Z agrees to this, as it has a good relationship with X. Z clears to Y the money X owed it. So, as a result, X is free of worry in the sense that it does not have to pay right away from its pocket. Y is happy because its request for early payment has been granted.
In all this, what is the financial institution, Z’s gain? Y’s request for earlier than scheduled payment will be met by X only on the condition that it accepts discounted payment. This difference in the amount is the earning that the financial institution, Z has made.
This is how supply chain finance is a win-win situation for everyone who is part of the supply chain. It works all the more efficiently in a situation in which the players involved are from different locations, as financial institutions have the infrastructure and resources to make payments across the globe at the touch of a button, and when the amounts of transaction are typically large.