Why SCF is not the answer to slow payments

Supply chain finance (SCF) is useful in many ways. One thing it is not is a solution to slow payment terms for smaller suppliers.

Supply chain finance (SCF) is useful in many ways. One thing it is not, however, argues Paul Christensen, CEO and co-founder of Previse, is a solution to slow payment terms for smaller suppliers. Until we recognise this, suppliers and buyers alike will continue to pay the costs.

Pressure on invoice payments is a constant challenge for CFOs. On the one hand, the needs of suppliers, corporate reputation and measures that come from the prompt payments reporting mechanisms are ratcheting up the requirements to pay faster. On the other hand, the realities of manually intensive payment processes and the requirement to manage cash flow are not going away.

On the face of it, supply chain finance (SCF) can feel like the silver bullet. You can offer all your suppliers payment upon approval, at an inexpensive rate. At the same time, you can maintain, or often even extend, payment terms, reaping the once-off balance sheet advantages.

In theory, at least, this should be the end of the story. But in reality, SCF in many cases, particularly for smaller suppliers, actually makes the situation worse, to the detriment of the whole supply chain.

According to the latest PwC Working Capital survey, over half of SCF programmes reach just 25 of the largest suppliers per buyer, and this is for buyers which have tens of thousands of suppliers.

This low rate of adoption is not for lack of need for early payment from suppliers.

Small suppliers, in particular, continue to struggle, with 50,000 going out of business each year in the UK alone, as a result of slow invoice payments, according to the FSB. Rather, given the significant administrative and technological costs of adopting SCF, the complexities inherent in its structure, SME suppliers – the suppliers with the most need for these programmes – are almost universally excluded from SCF programmes.

Onboarding a new supplier into an SCF programme involves complicated documentation, including the pledging of collateral and giving commitments that there is no conflict with existing floating charges or loan covenants. The level of documentation required is substantial and often requires more time and expertise than a small supplier has. In addition, many SCF programmes require suppliers to use their buyers’ e-invoicing technologies, which create additional costs well beyond the resources of most suppliers.

An SME supplier might have several large buyers which are each employing a different e-invoicing system and will each require a separate set of documentation for their SCF programme. It is extremely expensive at best, and more likely practically impossible, for the supplier to enter all these programmes and no individual relationship is worth enough to justify the cost on a case by case basis.

Putting all this together, the majority of suppliers, especially those most vulnerable to slow payments, are shut out of SCF programmes entirely.

In many instances, however, the inability to access SCF programmes run by their buyers are worse than being offered no early payment solution at all. It is common for buyers that run SCF programmes to also extend their payment terms, believing that their suppliers will be protected by the SCF facility. This leaves small suppliers who cannot access SCF not only without early payment, but facing longer payment terms than before the SCF programme started. This was perfectly illustrated by Carillion, which rolled out SCF programmes from 3 banks while doubling its payment terms from 60 to 120 days.

Clearly, this is a disaster for SME suppliers with already stretched balance sheets. However, it hurts buyers at the same time, costing money which more than wipes out the gains from the extended payment terms.

When a supplier accepts lengthy payment terms, their price is made up of three components. Their margin and costs of production are wrapped up with the cost of financing the gap between delivery of the goods or service and payment. While many SME suppliers seek to hide the strain on their balance sheet from their buyers for fear it will damage their ability to win business, many suppliers struggle with cashflow as a result of slow payments and are forced to take out expensive finance, typically with APRs above 20%, as a result.

If suppliers displayed the cost of the goods or service and the cost of funding their payment terms in the invoice, undoubtedly finance teams would baulk at the cost of the financing. They would almost certainly decide to pay earlier, at a discount, and take the cost of financing on themselves, given that their own cost of credit is a fraction of that which a small supplier can secure. Payment terms, in effect, mean that buyers bundle an expensive financing transaction with their purchase, putting themselves at a significant disadvantage compared to having simply called on their bank to provide them with an equal sized loan.

Extending payment terms as a result of SCF only increases these costs for buyers and magnifies the inefficiencies.

SCF has its place in the arsenal of the CFO. For a large buyer, it can be an effective balance sheet optimisation tool and provide meaningful value. But until we stop seeing SCF as part of the slow payment solution, most suppliers will continue to suffer in silence and buyers will continue to overpay.

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