Supply Chain Financing existing methods (Competitors)

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For buyers, credit terms imposed on their suppliers imply having more free working capital that allows them to conduct daily operations, make investments or finance their own supply chain finance programs. The problem a buyer usually finds when leveraging becomes the norm is that, excessive leverage over small suppliers might create them enough problems to go out of business, new suppliers will be more reluctant to provide credit terms and paradoxically the buyer itself may need to dedicate part of its capital to fund supply chain programs for its suppliers.

The main limitation of buyer-funded supply chain finance programs is that the availability of funds by the average sized company is very small compared to that of financial institutions, and the expected rate of return for capital might not be equivalent as well. This is the main reason for the existence of supply chain programs funded by investors.

2.1.1. Supply Chain Financing existing methods (Competitors)

The existing methods for supply chain include own funding, short term borrowing from traditional financial institutions, factoring, dynamic discounting, and forfaiting. Each method will be individually explained to understand the differences, advantages and disadvantages.

Short term borrowing: banks traditionally provide solutions for both buyers and suppliers when the need for working capital arises. This is especially true when the company is not able to emit commercial paper, issue stocks or have a large percentage of current assets committed to other projects. In countries where banks have monopolistic characteristics, financial markets are underdeveloped and the goods markets themselves have monopolistic traits, rates tend to be higher, as access to capital is ensured mainly for the established oligarchies.

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Factoring: form of accounts receivables purchase in which accounts receivable are sold to a third party at a discount. The third party is then responsible for collecting the payment of the outstanding debt. There are options of negotiating with recourse or without recourse. Factoring with recourse means that the seller of the accounts receivable will bear all the risk for any uncollected debts. Factoring without recourse places the risk of uncollected debts on the Factor or the purchaser of the accounts receivable. Furthermore, any issues regarding merchandise returns and all associated costs must be borne by the seller of the accounts receivable. Typically, the advance payment covers around 80% of all accounts receivable, and the remaining 15-20%

minus the interest expense for early payment will be paid when collections are performed.

Figure 4 indicates the sequence of processes for a typical factoring transaction.

Dynamic discounting: agreement term between sellers and buyers that ensures a discount for the total value of the invoice if payment is received within a specific time period. For example, the discount term 2%,15, Net30 is interpreted as follows. If the buyer decides to approve an

Figure 4: Factoring process diagram

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attractive solution. Figure 5 gives an example of an escalated dynamic discount, in which depending of the days for early payment, a corresponding discount is assigned to the invoice.

For 15 days the company would get a 1.2% discount over the invoice, for a 20 days’ early payment 1.0% discount, and for 40 days zero discount.

Forfaiting: method for exporters to sell medium to long term receivables that are owed to him by an importer through a third party. It works for large transactions, and reduces risk for the exporter, placing the risk on a financial institution or a third party investor. Usually transaction amount ranges from $250,000 to $500,000. Forfaiter bank serves as a risk taker and to provide early payment to the exporter. The forfaiter bank will wait for full payment at maturity from the Issuer bank (Bank in the country of the importer). The issuer bank receives payments of the debt until maturity, and provides collateral for the transaction, while also asking for collateral from the Importer. Mainly the costs of the transaction are diverted to the importer. Figure 6 summarizes the players in a forfaiting transaction, the sequence of steps and the direction of the flow of information, documents and money between the players. Basically all the risks are diverted to the financial institutions, which in turn require collateral from the importer (credit history and physical assets help engage in bigger transactions).

Figure 5: example of dynamic discount

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In order to provide a better comparison between all the traditional methods of supply chain financing Table 1 was constructed. It displays information about all stakeholders, corresponding rates, advantages and disadvantages of each method. Basically when the complexity of the financing method increases, so do the costs associated with them, and may be out of the reach of companies without enough collateral, or credit history.

Another aspect to consider for advantages and disadvantages of every method, also requires understanding for what activities is each financing method suitable for. International trade, and local trade have varying necessities, warranties and costs. It can be said that factoring and forfaiting are most suitable for middle to long term transactions in international trade; and short term borrowing and dynamic discount the most common methods for local trade.

Figure 6: typical forfaiting process diagram

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Table 1: Summary of advantages and disadvantages of common supply chain financing

Method/

Characteristic Funder Beneficiary Average

Rates Advantages Disadvantages Popularity

Short Term

Discount Buyer Supplier -

Buyer 1% - 3%

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