As a business owner, managing your cash flow and working capital is a crucial aspect of ensuring the success and sustainability of your company. Supply chain finance and factoring are financing solutions used to help businesses manage their cash flow and optimize their liquidity. Although these terms are similar, there are some important differences between the two. Let’s take a closer look at both supply chain finance and factoring, as well as who uses them and how they differ.
What is Factoring?
Factoring, also commonly referred to “invoice financing”, is a financial solution that enables companies to access funding by selling their accounts receivable (invoices) to a third party, known as the “factor”. The factor pays the company 80-90% of the invoice amount right away. Once the customer pays the factor, the remaining funds are sent to the company, subtracting any previously agreed fees.
Factoring provides a valuable solution for small and medium enterprises (SMEs) to access working capital, as well as a way to manage their accounts receivable and reduce the risk of default. By selling their invoices, these businesses can access cash quickly, which can be used to meet their short-term working capital needs.
Here’s an example of how factoring works:
Company A has several invoices that are due to be paid by its customers in the coming weeks. The company is in need of immediate funds to cover its own expenses so they decide to sell the invoices to a factor for immediate payment, usually around 80% of the invoice total. The factor then collects payment from Company A’s customers, and after the invoices are paid in full, Company A receives the remaining amount, minus any fees agreed upon with the factor. This allows the business to access immediate funds without having to wait for its customers to pay the invoices.
What is Supply Chain Finance?
Supply chain finance (SCF), also known as “reverse factoring”, is a buyer-led financial solution that enables businesses to access funding to support their cash flow and working capital needs. The basic idea behind supply chain finance is to help suppliers get paid faster while enabling buyers to manage their cash flow more effectively. Supply chain finance provides benefits for companies in diverse industries such as automotive, electronics, manufacturing, pharmaceutical, and retail, among others.
In supply chain finance, the buyer, usually a large company, works with a financial institution to provide early payment to its suppliers. The financial institution then collects payment from the buyer on the due date of the invoice. This finance tool benefits both buyers and suppliers in the supply chain, as buying organizations can extend their payment terms while suppliers receive payments earlier. Additionally, supply chain finance can be implemented without the need for a bank, which provides flexibility for companies of different sizes and credit ratings.
Here’s an example of how it works:
Suppose Company A (the buyer), has an agreement with its supplier, Company B, to pay for goods or services within 60 days. However, Company B needs the funds sooner to cover its own expenses. In this case, Company A can initiate the supply chain finance process to help Company B get paid earlier. Company A would reach out to a financial institution, and enter into a supply chain finance agreement. Under this agreement, Company B can sell its invoices to the factor and receive an early payment at a discount. The factor would then take over the responsibility of collecting payment from Company A. This way, Company B can access the funds it needs to cover its expenses without having to wait for Company A to pay the invoice. Company A also benefits from the arrangement, as it has the opportunity to extend its payment terms and improve its working capital position. Supply chain finance offers a win-win solution for both buyers and suppliers in the supply chain.
Supply Chain Finance vs. Factoring
Factoring and supply chain finance may seem alike, but there are certain distinct aspects that set them apart. Both provide businesses with the means to obtain early payment, helping to maintain a positive cash flow and ensuring seamless operations. Both solutions offer non-debt financing with lower fees compared to most bank loans and without high-interest rates. However, there are some differences between the two.
Factoring is an arrangement that involves two parties, namely the company and the factor. On the other hand, supply chain finance is a financial solution that involves three parties, the buyer, the supplier, and the financial institution. In contrast to factoring, where the supplier starts the process, in supply chain finance it is the buyer that makes the first move. Supply chain finance is a process where a large company arranges for its suppliers to receive early payment for their invoices. This method is more cost-effective for the supplier as the lender takes on the risk associated with the larger company instead of the smaller supplier. The fee charged by the lender is based on the buyer’s creditworthiness. This process is more straightforward and the payment schedule is clearly defined, minimizing the potential for delays or confusion.
Conclusion
To summarize, both supply chain finance and factoring can be valuable tools when it comes to helping your business grow. When choosing between supply chain finance and factoring, it’s important to consider your specific business needs and circumstances, as well as the terms and fees associated with each financial instrument.
If you are looking for a supply chain finance program for your business, get in touch with Liquiditas. Liquiditas offers a comprehensive and flexible supply chain finance solution to companies operating in diverse industries. Our team is committed to working closely with both buyers and suppliers to create a tailored supply chain finance plan that meets the needs of both parties. Contact us to learn how we can support your company’s financial needs and help you unlock liquidity in your supply chain.
