Procurement procedure
Supply Chain Finance
Arrangements allowing suppliers to be paid early against approved invoices, funded by a third party at the buyer credit rating.
Definition
Supply chain finance, also called reverse factoring, is an arrangement in which a funder pays a supplier early against invoices the buyer has already approved, and the buyer then pays the funder on the original due date. Because the funding is priced against the buyer's credit rating rather than the supplier's, a small supplier can access cash at a cost it could not obtain on its own borrowing. It is distinct from ordinary invoice factoring, which the supplier arranges independently of the buyer.
How it works in practice
The buyer sets up a facility with a bank or specialist funder and onboards suppliers to a platform. When an invoice is approved for payment, the supplier can choose to take the money immediately, less a discount, or wait for the standard payment date and receive the full amount. The buyer's own cash position is unchanged or improved, since it pays on the original terms, and the supplier converts a receivable into cash.
In UK public procurement the picture is more nuanced than the mechanics suggest. Government has promoted supply chain finance as a way of getting cash to smaller firms in long supply chains, and it is used in some large programmes. However, the collapse of Carillion in 2018 drew scrutiny to the practice, because extended payment terms combined with a finance facility can disguise what is effectively borrowing while presenting it as trade payables. Since then, reporting expectations around payment practices have tightened and buyers are more alert to the difference between paying suppliers promptly and financing late payment.
For suppliers the assessment is commercial. Early payment has a cost, and that cost should be compared against the alternative sources of working capital and against the risk of waiting. It is also worth reading how the facility interacts with contractual payment terms: a facility offered alongside terms of sixty or ninety days is a different proposition from one offered alongside thirty day terms, and public sector contracts flowing down a thirty day requirement under PPN Prompt Payment should not need one at all.
Common questions
Is supply chain finance the same as factoring?
No. Factoring is arranged by the supplier, who sells its receivables to a funder, and pricing reflects the supplier's own credit risk. Supply chain finance is arranged by the buyer, applies to invoices the buyer has already approved, and is priced against the buyer's credit standing, which is usually why it is cheaper.
Does using a facility affect prompt payment obligations?
It does not remove them. Central government contracts require payment within thirty days and require that term to flow down the supply chain. Offering a finance facility is not a substitute for paying on time, and buyers assessing performance under PPN 03 look at actual payment days rather than at the availability of early payment options.
Should a small supplier use it?
It depends on the discount rate and the alternatives. If the cost is lower than an overdraft or invoice discounting facility and cash flow is tight, it can be sensible. If contractual terms are already short, the benefit is marginal. The decision should be made on the numbers rather than on the convenience of the platform.
Why is it sometimes criticised?
Because it can mask the effect of long payment terms. If a buyer extends terms and then offers financing to relieve the pressure it has created, the supplier pays for the buyer's working capital benefit. Accounting treatment has also been contentious, since large facilities can sit in trade payables rather than being presented as debt.
