Alternatives for Monetizing Trade Payables (or Receivables)

Here's how to distinguish between the three primary approaches to supply chain finance—and when to leverage each one.

As anyone who regularly deals with supply chain issues knows, buyers and suppliers of goods and services usually have conflicting interests. Supply chain managers at most companies are under pressure to improve the company's cash efficiency, usually by extending payment terms to their suppliers. But many suppliers lack the financial strength or flexibility to adjust to longer payment terms. For example, if a supplier already has a highly leveraged balance sheet, increasing bank borrowing to finance short-term working capital may be prohibitively expensive. Extended payment terms may also expose suppliers to increased commodity or foreign exchange risk.

When a large, well-capitalized company is buying goods or services from a small or highly leveraged supplier, it may be in a position to use its own balance sheet to support the supplier. A number of strategies have emerged in recent years to help buyers and suppliers leverage the buyer's stronger financial position to help the supplier access lower-cost liquidity, often so that the supplier can then offer the buyer extended payment terms. Most of these strategies involve monetization of the supplier's trade accounts receivable.

The most common forms of trade receivables monetization include open-account-based supply chain finance and negotiable-instrument- based supply chain finance. Together, these two strategies are often referred to as "structured vendor-payables finance" or "reverse factoring." A third, related strategy is non-recourse receivables purchase, which is often incorrectly referred to as "factoring."

How Open-Account Supply Chain Finance Works

An open-account structured vendor-payables program involves the sale of receivables owned by various suppliers and owed by one particular buyer. The suppliers sign up to negotiate and sell their receivables to investors via a bank or another company running an Internet-based platform. To maximize economies of scale, a buyer usually wants to have a number of suppliers taking part in its open-account program.

Depending on the size of the supplier base, the investors purchasing the receivables generally consist of a single bank or a small group of banks, although receivables are sometimes sold on a blind trading platform, in which case they may be purchased by any number of investors. The universe of possible investors is usually made up of the relationship banks of the buyer, but this is not always the case. In recent years, a number of alternative investors such as hedge funds and insurance companies have also appeared in the market.

The platforms on which receivables are submitted, approved, and sold tend to be similar across most open-account structured vendor-payables programs. A supplier will sell goods or services to the buyer, generating an invoice that it posts on the supply chain finance platform for the buyer's confirmation. Once the buyer confirms the invoice as valid, the related receivable becomes eligible for purchase by an investor. Only confirmed invoices are eligible for purchase, so a specific transaction can be sold only if both the supplier and the buyer agree to have it sold.

In confirming the invoice, the original transaction's buyer agrees that it will pay the investor the full amount of the invoice on its due date without any claim, abatement, deduction, reduction, or offset of any kind. This confirmation enables the investor to look directly to the buyer for payment. The buyer may...