Supply Chain Finance - The DrGrep Jargon Buster

Supply Chain Finance (also known as SCF) is commonly used to cover wide range of financing activities. Some of these activities are buyer-led, whilst others are supplier-led. Some of these activities are bank-funded, whilst others are funded by alternative lenders or the buyers themselves. To make the matters worse, Supply Chain Finance is also commonly used to describe the specific activity of Reverse Factoring, with the terms used interchangeably and often incorrectly.

Hence why we decided to explain each term inside the circle of SCF and how are they different from each other. The Jargon Buster below should help to clarify the different financing activities commonly used by buyers and suppliers.

REVERSE FACTORING

(AKA Supply Chain Finance, Approved Payables Finance)

Reverse Factoring involves three parties — the Buyer, their Suppliers & an External Financier (e.g. Banks or NBFCs or other financial organizations). It is typically initiated by the buyers as a way to reduce the risk of insolvency within their supply chain. Suppliers can elect to receive early payment on their invoices, funded by the financier, at cheaper rates than they could access themselves. In this scenario, Suppliers are effectively borrowing against the credit rating of the larger, stronger Buyer with whom the risk of default sits.

Aside from benefitting from a healthier supply chain, the Buyers would usually take a share of the bank’s margin, or benefit from extended payment terms. Whilst banks have an overwhelming majority of the reverse factoring market, new entrants have emerged leveraging technology platforms and alternative sources of finance.

FACTORING

(AKA Accounts Receivable Financing, Accounts Receivable Factoring, Invoice Factoring)

Factoring is a form of Asset Based Financing where a company is able to sell its invoices in return for immediate cash flow. It is a way for companies to alleviate their cash flow troubles when faced with long payment terms. Typically, the factor will take possession of the company’s sales ledger and collect the debt directly from the debtor. The company will receive c.80–90% of the invoice value up front, with the remainder transferred when the debt is received in full- minus the factor’s fees and interest charges.

DISCREET FACTORING

(AKA Invoice Discounting)

Discreet Factoring is closely related to factoring, with the key difference that credit control remains within the business. As such, the factor does not collect the debt directly from the debtor. Businesses may prefer this discreet approach so as not to signal liquidity issues that could damage their customer relationships. There is some regional variation as to whether discreet factoring is considered a debt (loan securitized by invoices) or a sale of invoices akin to factoring.

EARLY SETTLEMENT DISCOUNT

(AKA Prompt Payment Discount, Early Payment)

Early Settlement Discount is the process where a buyer is able to capture discounts by paying their supplier invoices earlier than originally agreed. An example of a typical discount would be “2/10 net 30” — meaning the buyer is able to deduct 2% off the invoice value if payment is made within 10 days on a 30-day invoice.

DYNAMIC DISCOUNTING

Dynamic Discounting is a form of early settlement discount. Dynamic discounts are calculated on a sliding scale whereby the earlier the invoice is paid, the larger the discount on offer. Dynamic discounts incentivizes buyers to pay their suppliers as early as possible, whilst at the same time giving buyers the ability to capture discounts at any point during the payment term.