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Supply Chain Finance or Invoice Factoring: Which Is Better for Managing Cash Flow?

Anne MacRae
Anne MacRae

Is supply chain finance right for your business, or would invoice factoring suit it better? Here's what you need to know about both types of financing.

Supply chain finance programs can be a way to get cash quickly. Before you pursue this path, make sure you research other financing options and understand what's best for your business. Invoice financing, while somewhat different, takes a similar structure in cash advancements. If you're confused about your overall options, work with a finance professional to better understand what's best for your business's specific situation.

Should you take part in a supply chain finance program?

Every day I hear about another company offering a supply chain finance (SCF) program or early-pay option for their suppliers. Most SCF programs are offered by large corporations with thousands of suppliers, such as Amazon, Walmart, Coca-Cola, Warner Bros., Nordstrom and Bell. Some of these corporations use their own cash to fund the programs, while others have partnered with banks or hedge funds to fund early payments to suppliers.

The 2018/2019 SCF Barometer from PricewaterhouseCoopers found that 55% of surveyed companies are participating in supply chain financing programs. Further, 41% of respondents that are not participating supply chain financing programs said they were considering it. 

As someone who has spent the past decade working directly with small and midsize businesses, providing them with working capital through accounts receivable financing, I have to ask myself, "Will supply chain finance replace invoice factoring?"

What is supply chain financing?

Supply chain financing, while a little complex, is a useful small business tool. It gives small businesses the opportunity to extend payment dates to suppliers without any impact to their credit scores and without the suppliers losing money.

In this scenario, the supplier can receive advanced payment on the outstanding invoices from a third-party funder. When the payment date comes for the small business a few weeks later, the business fulfills the payment and the money goes to the funder or supplier, depending on which holds the account at that time.

 

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To be clear, this supply system is not a debt or a loan – it's a tool small businesses and suppliers can use to free up capital via third-party funder. While third-party funding institutions may charge a fee for each transaction, this is not an asset-based lending program. This is the main difference between supply chain financing and invoice factoring.

What is invoice factoring?

Unlike supply chain financing, invoice factoring is a type of small business loan. Invoice factoring is a tool businesses can use to get money on outstanding invoices immediately. They work with a third-party lender that will buy outstanding accounts receivable. While it may sound similar to supply chain financing, this is an asset-based lending program where a company's accounts receivable acts as collateral.

Invoice factoring can be a quick, easy way to get cash upfront. Keep in mind that factoring companies will charge fees for each transaction and may buy accounts receivable at discounted rates.

Supply chain financing vs. factoring: What's the difference? 

Unlike factoring, where a supplier sells its receivables at a discount to a third party (a factor) for early payment, supply chain finance is a financing solution initiated by the buyer where the buyer agrees to pay an invoice early for a discount. The benefit to the buyer is a discount off the invoice price.

The benefit to the supplier is early payment, usually at a discounted rate less than factoring. It's a new electronic take on the old 2/10 net 30 payment term, but the buyer initiates the request for early payment through the use of technology.

Pros and cons of invoice factoring

Pros

  • You get quick access to capital.
  • Accounts receivable is responsible for final payment.

Cons

  • Your accounts receivable is treated as collateral.
  • You may not receive the full amount of an outstanding account.

Pros and cons of supply chain financing

Pros

  • It's not an asset-based lending program.
  • It's a fast way to free up cash.

Cons

  • The third-party company may take a small fee.

Will supply chain financing replace invoice factoring?

No, I don't believe so. Why?

Supply chain financing does not change the unbalanced relationship between big buyers and smaller suppliers. Factoring has been around for hundreds of years, because when a smaller supplier sells to a bigger buyer, it is the bigger buyer who determines when they will pay their invoice, often regardless of the payment terms they agreed to.

Supply chain financing does not change this relationship. It is initiated and controlled by the buyer. The buyer decides which suppliers can participate, how quickly they will pay and what discount they will demand. Some buyers may not have the money, technology or interest to offer it to all their suppliers, offering it only to their biggest suppliers. Others may offer it today only to take it away tomorrow without notice because of changes in their cash flow position or priorities. The power remains with the buyer, and the supplier remains at their mercy for payment.

Invoice factoring gives you more control.

Factoring changes this dynamic, because it is initiated and controlled by the supplier. With factoring, the supplier determines which invoices they will factor and when based on their cash flow needs. They are in complete control. They know the cost ahead of time and can factor it into their pricing.

Technology is making invoice factoring paperless.

One drawback of factoring is it could be labor-intensive, with copies of invoices needing to be submitted to and verified by the factor. The increasing use of technology such as e-invoicing and e-payment makes factoring easier and more streamlined. Online vendor portals make it easy for a factor to view and confirm invoices.   

Be in control of your cash flow.

Not long ago, one of my factoring clients received an email from a customer inviting them to participate in an early payment program. All they had to do was press a button and a discounted payment would be sent to them within seven days versus the standard 30-day term. My Canadian client sells to both Canadian and U.S. divisions of this major retailer as well as dozens of other customers. The early payment offer was available on the U.S. invoices only of this one customer.

So, if one of your customers invites you to participate in their supply chain finance program, you should ask yourself, "Has anything really changed?" Yes, you may get paid sooner for a discount, but you may not. What guarantee do you have that it will be available on your next invoice, and on the one after that?

With factoring, you are in control. You determine which invoices you will factor and when to meet your ever-changing cash flow needs. You deal with one factor for all of your invoices instead of working with a different program, process and platform for each customer.  

Are you wondering what happened with my client invited to participate in the supply chain finance program? They passed. It offered little benefit to them, as it only applied to a very small portion of their accounts receivables and did not give them the control to manage their cash flow as needed.

Matt D'Angelo contributed to the writing in this article.

Image Credit: fizkes / Getty Images
Anne MacRae
Anne MacRae
business.com Member
Anne MacRae has been in the factoring, trade financing and asset based lending industry since 2006 and is the Vice President of Business Development with Express Business Funding, a leading? factoring and ABL company. Prior to EBF, she held senior sales roles with Trade Finance Solutions and the Interface Financial Group. Having owned her own business in the past, Anne brings a deep understanding of the challenges entrepreneurs face in obtaining financing and has used this experience to help hundreds of clients secure funding to grow their businesses. Anne sits on the board of directors of the International Factoring Association, Canada Chapter, and is a regular contributor on panels and in publications on alternative lending.