Is SCF the Right Solution for SMEs?

SCF is not a single technique, but a collection of techniques generally categorised as either receivables purchase or loan-based receivables financing, and within which there are different methods or techniques. For example, receivables discounting, factoring, forfaiting and payables finance are different techniques for receivables purchase, and they may be known by different names depending on the preference of the providers and/or their clients.

SCF is usually organised as a scheme or program for ongoing transactions. It can be originated by/with the buyer or supplier. The term SCF is often narrowly associated with buyer-led financing arrangements for suppliers, what is called payables finance, reverse factoring, supplier finance or simply 'SCF'.[1] Under such buyer-led arrangements, the buyer arranges with a financing institution to provide financing to its suppliers – usually suppliers with long term supply contracts, who need to be onboarded or enrolled in the financier’s SCF program – based on the buyer’s approved payables for these suppliers for which the financier is appointed by the buyer as a paying agent.

SCF providers promote such programs with large corporate buyers, whose incentives include managing their net working capital position by lengthening payables days – this is done by getting suppliers to agree to the credit terms the buyers want in exchange for an early payment scheme. They are marketed as win-win arrangements for both buyer and supplier – the buyer achieves its working capital goals, and the supplier receives early payment for its credit termed sales to the buyers. The financier of course wins by an often-sticky revenue stream from the program, priced somewhere in between the risk pricing of the large corporate and the usually smaller suppliers thereby achieving ‘above-market’ returns on capital allocated for the buyer’s risk.

Buyer-led SCF schemes have been criticised by some quarters as being unfair to suppliers. Buyers are accused of arm-twisting their suppliers into extending credit terms in exchange for the financing, and of improperly accounting for bank debt as trade payables. It has been said that if buyers wanted to secure their supply chains, they should pay the suppliers earlier. But it must be remembered that every company is both a buyer and a supplier, and they all have the objective of minimising their net working capital or cash conversion cycles, by managing the levels of their working capital components: inventory, trade receivables and trade payables. For businesses to extend credit and carry inventory, they need to be extended credit for their inventory (trade payables) and fund any working capital gap with either equity or borrowings. SCF techniques assist businesses to reduce receivables and secure suppliers' credit.

Enrolment in its customer’s payables finance program is an option for the eligible supplier. SMEs can evaluate whether this option is attractive vis-à-vis their other options, viz. alternative external financing arrangements e.g. factoring, overdrafts, bank loans, with their own relationship lenders. If the SME supplier has few or no better options, then being able to avail financing from its customer’s payables finance program cannot but be a boon.

If the pricing is not exorbitant when compared to other financing options, buyers’ SCF programs should generally be advantageous to SMEs, as they would be able to use their customers’ financing limits to sell to these customers and reserve their bilateral financing limits with their own financiers to grow their business with other customers.

Financial institutions tend to arrange payables finance programs for investment grade corporates (and sometimes for those one to two notches lower); the distance between the credit rating of the majority of SMEs and those of their large corporate customers often provide enough pricing arbitrage to make the rates offered to SME suppliers attractive.

Besides, most of these payables finance programs are on non-recourse basis to the suppliers (if they were not, they ought to be made so!), and that is of value to the suppliers because it means that the financial institution provides not only liquidity but is in fact prepaying the supplier, and the supplier has no repayment obligation to the financial institution unlike an overdraft or a loan.

Footnote(s)

[1] The Global SCF Forum uses the term ‘Payables Finance’ as a generic and neutral expression for financing provided through a buyer-led programme within which sellers in the buyer’s supply chain are able to access finance by means of receivables purchase. See: https://supplychainfinanceforum.org/techniques/payables-finance/

This is an extract from my article of the same title published by BCR on 31 August 2021: Is SCF the right solution for SMEs? | BCR Publishing