This particular article is an opinion piece posted in Bloomberg and discusses the use and relative risk of certain types of supply chain finance (SCF). As one may surmise from the results of an artificial economic slowdown, the need for cash is an existential concern for many suppliers, especially as you move towards the long tail of spend.
The author suggests that there is a recent demand for certain types, but SCF has been gaining in popularity now for a long time. There is also a definitional nuance since just about all techniques can be called a variation of SCF, but often segmented into different types.
‘As is so often the case, those creative types in the finance industry have come up with a smorgasbord of ways to help firms increase their cash holdings. The oldest and most common is called “factoring.” Essentially, if you’re a cash-strapped company whose customers are dragging their feet on paying their bills, no problem: A bank will give you an advance on those invoices, for a fee. Another increasingly fashionable technique is a more complicated service known as “reverse factoring” or “supply-chain finance.” This allows a company’s suppliers to get paid what they’re owed quickly. The company then refunds the finance provider at a later date.’
Mercator Advisory Group covers the space frequently, most recently in a member Report on trade finance. Today’s most commonly used SCF tool is reverse factoring, which relies upon the buyers’ credit worthiness to finance early supplier payments at a discount.
The author goes on to explain the pitfalls of these type of financing arrangements, which are based on a free flowing and somewhat predictable ongoing sales pattern. So what happens when sales drop off and existing assets can’t be paid by buyers and sellers have few invoices to sell? The author provides a few example of these situations so the article is a good read for those looking to get more familiar with the topic.
‘Taken together, these four cases show the pitfalls of this technique. If invoice-financing can cease just when it is needed most, that’s all the more reason for investors to treat it as quasi-debt. And it’s imperative that disclosures, particularly around reverse factoring, are improved. Ultimately investors need to understand exactly how a company is generating cash.’
Overview by Steve Murphy, Director, Commercial and Enterprise Payments Advisory Service at Mercator Advisory Group
