Supply chain financing (SCF) has been viewed as a mainstream working capital solution, alongside traditional tools such as letters of credit. It aims to optimize cash flow and payment terms to suppliers and across every businesses chain. Indeed, a sophisticated and efficient approach to working capital management has been mooted as a way to boost SME growth at a time of weak economic activity. However, the jury is out on the scale of SCF adoption.
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| Kate Sharp, CEO at ABFA |
“SCF is an ideal tool for leveraging the strong credit rating of a large buyer as a mechanism for getting lower-priced funding to much smaller businesses with weaker credit ratings,” says Kate Sharp, CEO at the Asset Based Finance Association (ABFA). “It offers a classic win/win situation.” However, she sounded a note of caution, warning buyers to use SCF ethically. “There is already a mismatch between the position of the buyer, which is one of power, and the supplier,” says Sharp.
“Introducing supply chain financing should not be a trigger for extending payment terms or preventing suppliers’ freedom of choice to use alternative forms of invoice finance if they wish to. We just need to be mindful the product is not abused.”
Used constructively, SCF allows large companies to provide liquidity at a reduced cost to their suppliers, which they might do if they are identified as particularly vulnerable, or if the relationship is strategically important, says Maureen Sullivan, North American trade sales head of global trade and supply chain solutions at Bank of America Merrill Lynch.
“For many, the attractiveness is that it is a win-win,” says Sullivan. “It is not about our clients extracting cost, but securing a working capital benefit where the supplier is not adversely impacted, or might also benefit.”
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| David Petrie, head of corporate finance at the ICAEW |
David Petrie, head of corporate finance at the Institute of Chartered Accountants in England and Wales (ICAEW), adds: “Some suppliers have a prejudice against invoice discounting because it can appear expensive. “However, if you factor in the reduction it can bring to your processing costs, by outsourcing some of the processing activity, it can be very cost-efficient and lead to regularization of payments.”
Part of the problem, then, is one of education. People need to better inform SMEs what their options are and what impact they might have on their business.
The high-street banks have a mixed record in communicating with their SME clients, but ICAEW is educating its members so that accountants can provide information if the banks are not delivering it.
Yet in this instance, a better understanding of the product might not be enough.
“This is a push rather than a pull product,” says ABFA’s Sharp. “A supplier can’t request this facility if the buyer doesn’t have an SCF scheme, and even if it does, it may only be offered to selected suppliers.
“Where an SCF scheme is not available to suppliers, they should consider using a direct invoice finance facility to boost their cash flow.”
ICAEW’s Petrie adds: “SCF isn’t appropriate for all buyers, some of which need to maintain an arm’s length commercial relationship with their suppliers.
“It is a tricky problem and the idea that manufacturers should pay suppliers more quickly is overly simplistic. Government intervention to legislate on appropriate payment terms is not necessarily the answer.”
Not all companies will be able to pay within the same timeframe, while different sectors have different traditions – steel tends to operate on a 90-day payment horizon, for example, while food tends to be seven-to-14 days.
“Payment policy and relations with key suppliers should be a matter for company directors and boards to determine,” says Petrie.
However, governments appear to take a different view, with the European Parliament having issued a directive that aims to set a limit of 60 days for buyers to settle bills with their suppliers.
It did concede that “there may be circumstances in which undertakings require more extensive payment periods, for example when undertakings wish to grant trade credit to their customers,” and accepted that payment periods longer than 60 days should be permissible, where expressly agreed by both parties, provided “such extension is not grossly unfair to the creditor”.
UK prime minister David Cameron has also been attempting to persuade CEOs of FTSE 100 companies to reduce payment terms for their suppliers, though there is no evidence the government has the appetite to back this ambition with legislation.
“The government is very reluctant to strengthen legislation, preferring to leave it to market forces, which is probably the right call,” says Sharp. She called on the media to play more of a role, putting pressure on large companies to treat their smaller suppliers fairly and to pay bills quickly.
The Forum of Private Business has taken a lead in this effort with its hall of shame, where it names groups seen to be treating its suppliers unfairly.
Among those named and shamed is Sainsbury’s, which recently extended the terms of payment for suppliers to 75 days, and GlaxoSmithKline, which extended from 60 days to as much as 95, depending on the date invoices are received.
SCF, which typically sees suppliers receive earlier payment from their buyers in exchange for a small fee, could ease the financial pain for a lot of SMEs.
“It isn’t always about the margin on sales – the terms around the sale are often equally important,” says Petrie. “It doesn’t matter if a business is highly profitable on paper. It can still run out of cash while it is waiting for bills to be paid.
“Banks should look at the way they price these kinds of facilities compared to overdrafts or other forms of short-term debt.
“In debt factoring, the bank has a good level of security in that it has legal title to a factored invoice so the risk should be quite low, yet these facilities are often more expensive than an overdraft. It is a peculiar anomaly in the pricing, which does not sit where you would expect, in terms of the risk reward characteristics.”
He adds: “For many small businesses, the lack of an extended overdraft or short-term loan facility from their bank is driving demand for factoring, despite the cost.”