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Dynamic Discounting & Supply Chain Finance: A Deeper Dive Part 2

Posted by James Wilson on Apr 29, 2019 12:24:45 PM
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As discussed in Part 1 of this blog series, companies strive to maintain margins and maximize cash flows by managing the variables over which they exercise control. Efforts from the Procurement team focus on maintaining competitive bidding for the material and service inputs needed in the production and delivery of goods or services to market. Once suppliers are identified and contracted by the buyer, a balancing act occurs to negotiate favorable payment terms and/or capture discounts and rebates. In return for these concessions, the buyer can now offer options to facilitate expedited payments utilizing technologies that offer processing efficiencies.  As with all trading relationships, the underlying dynamics are needed for both the buyer and supplier to manage counterparty risk, remain competitive, and maintain individual profitability.supply chain finance

Part 1 of this blog series spoke in depth about dynamic discounting. This proven concept allows the buyer to offer an early payment option to the supplier at a discount. This solution accelerates cash collection for the supplier to support their working capital needs while allowing the buyer to deploy excess cash and enjoy savings on the cost of goods and services purchased yielding a higher rate of return than typical short-term investments.

Part 2 (this blog) will focus on a similar product called supply chain financing (SCF) which is also known as reverse factoring. So, what is supply chain financing?

On the surface, the supply chain financing concept is simple: Supply chain financing is a solution that offers the buyer the flexibility to extend payments while giving suppliers a choice to accept a discount for early payment on a transaction-by-transaction basis. The supplier can configure the technology platform to clear their receivables electronically and post the settlement entries to the general ledger automatically. Like dynamic discounting, this creates operating efficiency savings that can be redeployed to other activities for both the buyer and supplier.

What differentiates supply chain financing from dynamic discounting is the opportunity for the buyer to extend payments utilizing a third-party funding institution working to facilitate the transaction. Mechanically, here’s how it works:

A buyer would issue a purchase order (PO) to a supplier for goods or services. Within the terms and conditions of the PO, the buyer can stipulate which payment terms they would offer. This new PO will set the stage for extending payment terms from Net 30 to Net 60 days. After the supplier understands their options and agrees to the new terms, provides the goods or services, and issues the invoice, the buyer would then perform a three-way match on the PO, invoice, and the receipt of the goods or services. Once everything is matched, the invoice would be approved for payment by the buyer.

At this point, the obligation is transferred to the third-party funding institution. The supplier could then be paid by the funder at their original terms of Net 30 less a discount while the buyer settles with the funder at Net 60 days. In order to be paid early, the supplier would agree to be paid at a sliding scale discount. The calculated discount is based on the buyer’s credit rating (not the supplier’s). This is an important distinction as it assumed that on average about 65% of suppliers in any buyer’s supply chain may be sub investment grade. Without the ability to leverage the buyer’s credit worthiness through a SCF program, suppliers may be left with only a few options to raise capital to fund their operations during cycles of excess cash usage such as a factoring program, or to borrow on a revolving facility if credit was available. The net effect after the transaction is fully settled by all parties is that the supplier received an early payment, the funder received a fee, and the buyer received a payment extension of 30 days.

The impact of supply chain financing has the following effects:

From the buyer’s perspective:

  1. Through the SCF program, the buyer now has the opportunity to extend payment terms (for example from Net 30 to Net 60 days) while the supplier can still collect at Net 30 days or less by accepting the discount. This terms extension improves DPO and unlocks working capital to the buyer.
  2. Since the buyer is utilizing the SCF platform to facilitate the transaction electronically, they can now avoid some manual processing steps to settle the transaction by configuring the system to recognize the payment, clear the payable, and post to the GL. The work effort that would normally be tied to manually processing this transaction could be repurposed to other work endeavors yielding additional savings and efficiencies.
  3. In summary, the SCF program generates processing efficiencies and savings for the buyer through managing the workflow electronically while yielding an extension to DPO to unlock working capital.

From the supplier’s perspective:

  1. Through the SCF program, the supplier now has the opportunity to improve their working capital especially in times of excess cash usage by collecting on receivables early which in turn, improves DSO.
  2. Since the supplier is utilizing the SCF platform to facilitate the transaction electronically, they can now avoid some of the manual processing steps to settle the transaction by using the system to transmit the invoice and recognize receipt of payment, which can then be configured to clear the receivable, and post to the GL. The work effort that would normally be tied to manually processing this transaction could be repurposed to other work endeavors yielding additional savings and efficiencies.
  3. In summary, by utilizing the buyer’s SCF program, the supplier now has the opportunity to improve working capital and DSO, while capturing processing efficiencies and savings that can be redeployed to other work efforts.

Final Thoughts:

Supply chain financing is a proven product that allows both the buyer and supplier capture savings and efficiencies generating win-win opportunities for both parties. It offers the buyer the opportunity to extend payments to increase DPO and unlock working capital while providing the supplier opportunities to raise working capital and decrease DSO. Both parties enjoy savings and efficiencies from electronic processing components that can be redeployed throughout the organization.  Nitor can help your organization achieve both dynamic discounting and supply chain finance optimization.

Topics: procure to pay, treasury and working capital, finance

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