Supply chain finance is the use of financing and risk mitigation techniques to improve the working capital of companies that trade with each other as buyers and suppliers. Its common feature is that funding is tied to actual commercial transactions, such as approved invoices, purchase orders or goods in transit, instead of being a general loan. Large companies use it to support their suppliers and manage their own cash, suppliers use it to be paid sooner, and banks and specialist platforms provide the money.
In everyday use the term often means one product in particular, a buyer-led programme also known as reverse factoring or payables finance. Industry bodies use it more broadly, as an umbrella for a family of receivables, payables and inventory techniques. It overlaps with traditional trade finance but is usually applied to trade on open account, where goods are shipped and invoiced without a letter of credit.
How a payables programme works
The typical buyer-led programme follows these steps:
- The supplier delivers goods or services and issues an invoice.
- The buyer approves the invoice and uploads it to a platform, confirming that it will pay the full amount on the due date.
- The supplier may choose to be paid early. If it does, the funder pays the invoice amount less a discount.
- On the due date, the buyer pays the full amount to the funder, or to the supplier if early payment was not taken.
The discount is based on the buyer's credit standing, not the supplier's, because the funder is relying on the buyer's confirmed promise to pay. A small supplier selling to a highly rated buyer can therefore obtain funding more cheaply than it could borrow in its own name. The buyer, for its part, can often agree longer payment terms without straining its suppliers.
Main techniques
Standard industry definitions group the techniques by what is being financed:
- Receivables purchase. The supplier sells its invoices to a funder. Forms include receivables factoring, invoice discounting, forfaiting and the buyer-led payables finance described above. The legal mechanism is a receivables purchase.
- Loans against receivables or inventory. The funder lends with invoices or stock as security, for example through warehouse receipt finance.
- Pre-shipment finance. The supplier borrows against a confirmed order to pay for materials and production, as in purchase order financing.
- Distributor finance. A funder finances the stock that distributors buy from a large manufacturer.
A related arrangement, dynamic discounting, involves no external funder: the buyer uses its own cash to pay early in return for a discount that varies with the number of days.
Effect on working capital
The appeal lies in the cash conversion cycle. A supplier that sells its receivable shortens its days sales outstanding. A buyer that lengthens terms raises its days payable outstanding. Both release working capital. For the supplier, a sale without recourse also removes the risk that the buyer fails to pay. Funders may protect themselves with trade credit insurance or sell participations to investors.
Accounting and disclosure
A recurring question is whether amounts owed under a payables programme are still trade payables or have become bank debt. If the terms change substantially, for example through much longer payment periods or added guarantees, reclassification as borrowing may be required, which affects leverage ratios and loan covenants. Critics argued that some companies used programmes to borrow without showing debt.
Standard setters responded with disclosure rules. Amendments to the international standards on cash flow statements and financial instrument disclosures, effective from 2024, require companies to disclose the terms of supplier finance arrangements, the amounts involved, where they appear in the balance sheet and the range of payment due dates. The US standard setter introduced similar requirements from 2023.
Risks and criticism
Programmes depend on the buyer's creditworthiness and on funders' continued willingness to finance. If a buyer weakens and funders withdraw, the buyer must suddenly pay suppliers from its own resources, and suppliers that relied on early payment lose liquidity at the same moment. The failure of the UK contractor Carillion in 2018 drew attention to this risk. The collapse in 2021 of Greensill Capital, a large provider, exposed further problems, including funding of invoices that did not yet exist and heavy reliance on credit insurance and short-term investor funding.
Suppliers' groups also complain that large buyers have used programmes to impose longer terms, leaving suppliers to pay for earlier settlement of money they would previously have received on time. Good practice guidance stresses that participation should be voluntary and that programmes should not be used to disguise late payment.