Why Is Supply Chain Financing a Lifeline for SMEs in Difficult Times?

In recent decades, small and medium-sized (SME) enterprises have become more prevalent in global supply chains because of globalisation.

However, the Covid-19 crisis has exposed them to the perils of transnational shocks and liquidity crisis.

In the tumultuous post-Pandemic economic climate, Supply Chain Financing as a financing option for SMEs has witnessed tremendous growth. It is also being seen as a lifeline through which SMEs can navigate the dangers of unforeseen events and maintain their operations efficiently.

Additionally, digital innovation in Supply Chain Finance (SCF) has offered a viable and effective means of streamlining much-needed funding for SMEs during difficult economic situations..

By embracing technology, SCF lenders are providing better and more profitable assistance to small and medium-sized businesses.

In this blog, you will explore Supply Chain Financing (SCF), its utility for SMEs in unexpected circumstances and how lenders can use it to increase profits.

What is Supply Chain Financing (SCF)?

Supply Chain Finance, commonly known as supplier finance or reverse factoring, enables businesses to grow their cash flow. Typically, they utilize their accounts receivable as collateral. Meanwhile, the process offers their large and small suppliers early payments.

Companies can use SCF to free up working capital to purchase inventory and raw materials.

Supply Chain Financing improves the transaction’s efficiency and reduces costs for all parties involved. Because the buyers with a better credit rating can easily access the capital at a lower rate than sellers.

The Workflow of Supply Chain Financing

Buyer and seller agree with the supply chain financier.
Transactions between the buyer and seller are recorded, and the seller issues an invoice.
The seller uploads the invoices to a cloud-based facility owned by the supply chain financier.
The payment is received from the financier, which is less than the invoice value because of financing charges for the early payment
Consequently, the financier approaches the buyer to receive the payment for the invoices on the actual due date.
the financing charges varies based on the agreement. Either party or both could handle it.

Supply Chain Finance(SCF) bridges the gap between incoming and outgoing payments by optimizing working capital and reducing supply chain risk.

Example of Supply Chain Finance

A customer buys goods worth 100,000 rupees from a seller on 31st October, the payment of which is due in 2 months. Now, the customer wants to delay the payment to utilize the funds in his own business, whereas the seller wants to get the payment immediately. They then approach a financier to get into a mutual agreement.

Now, after the invoices worth 100,000 rupees have been raised by the seller on the customer, it transfers the invoices to the financier. After due diligence, the financier transfers the entire amount, less the financing charges, to the seller, for example, 95,000. The seller can utilize the advance payment received.

Also, after a couple of months, due invoices are scheduled for 30th December. Then the financier approaches the buyer to receive payment for the invoices. The financier receives a total payment of 100,000.

The financier earns the charges of 5,000 plus any other interest it might have levied.

In this way, the seller gets advance payment by paying a small amount, and the buyer can pay on the actual date or an extended invoice date.

The Benefits of Supply Chain Finance to SMEs

Supply Chain Finance (SCF) is a set of technology-enabled solutions that connect SMEs, their buyers, and financial institutions onto one platform. SMEs can accelerate cash flow, receiving lower financing costs and visibility into outstanding customer invoices and payment schedules.

Increased efficiency: SCF is offered by lenders as a means to allow SMEs to simplify their operations and manage their risk more effectively by financing the supply chain activity. It reduces the time needed to secure funding and allows SMEs to recalibrate their operations and performance.
Improved cash flow: SMEs can increase their cash flow by getting payments in advance.
Improved customer relationship: SCF improves customer relationships and facilitates future trades, allowing the business to carry on production and invest in the firm’s expansion.
Reduced costs: The financing cost is relatively less than traditional borrowing. This can save the SMEs’ resources, which can be reinvested into other operational areas.
Improved access to Credit: Supply Chain Finance enhances access to credit for SMEs, giving them more flexibility in how they use credit. It helps them improve their chances of securing funding when required.

Challenges in Supply Chain Financing for the Financier

Large companies with robust cash flows and customer relationships have easy access to credit due to their reputation.

However, for small and medium-sized enterprises (SMEs), there is a need for due diligence on the part of the financier to check the creditworthiness of the SME and their customers.

Some challenges include:

Digital and technological challenges: Building cost-efficient digital products for the customers becomes difficult for the financier and leads to dilution of attention from its core activity, such as lending.
Compliance risks: Since SMEs deal in small business transactions, there are fewer compliance requirements. This is why the financiers have to ascertain that no compliance risks are involved.
Credit evaluation: Financiers have to evaluate the SME’s creditworthiness and their customers’ SCF to decrease the risks of default.
Documents verification: With the rise of digital transactions, malpractices have also risen substantially. The financier must ensure that all the invoices submitted by the SME and their customers are authentic and leave no scope of forgery.

Bottom Line

Supply Chain Finance was traditionally seen as a solution for more prominent companies with solid credit histories, with much of the process being manual, time-intensive, and paper-based. This is why it took a lot of work for lenders to assess the viability of smaller businesses.

With the advancement of digital technology, there are plenty of opportunities for SMEs to avail the benefits of quick financing options like SCF. As SMEs account for the majority of the economic activity in the country, Supply Chain Finance can be seen as a viable finance alternative.

How Finezza Can Aid Your Supply Chain Finance Journey

The financiers that recognize the economic potential of Supply Chain Finance and choose to partner with Finezza could equip their organizations to handle the financial landscape in the years to come. This is because Finezza has developed a wide variety of products that aim to solve all your lending needs.

For example, Finezza provides tools like

Loan Management System to help in keeping track and managing credit applications
Loan Origination System for facilitating the creation of loan documents to save up time, and helps provide proactive monitoring of loans.
Document Identification Framework to process KYC documents faster and streamlines the entire Supply chain finance process.