March 26, 2021 | by Maureen Sullivan, Managing Director, Business Head Supply Chain Finance, MUFG

As we enter a post-pandemic economy, suppliers are tapping their receivables as a source of liquidity to emerge stronger and more resilient than ever before.

Receivables are legally enforceable claims for payment held by a business for the goods it supplies or services it renders that customers have ordered but not paid for. These claims usually take the form of invoices issued by the supplier and delivered to the buyer for payment within an agreed timeframe.

The liquidity challenge for suppliers

Like many companies, suppliers faced liquidity shortages during the past year due to pandemic-related economic upheaval. In some cases, excess demand for certain goods overburdened suppliers’ production capacity and drained them of working capital. In other cases, lower demand for goods caused income shortfalls. And physical disruptions in the manufacturing or delivery of goods, in some cases, delayed payments. Many cash-strapped suppliers could not afford to wait the full 60- or 90-day payment terms set with the buyers who acquired their goods—a timeframe that would deprive them of the funds needed to sustain their operations.

To shorten their cash conversion cycles, growing numbers of suppliers enlisted in supply chain finance programs, which enabled them to sell their receivables to a bank in exchange for immediate cash. The bank then collected payment from the buyer at a later date in accordance with the payment terms established between the buyer and the supplier. Suppliers gained quicker access to money owed —money that would otherwise have been inefficiently suspended until collection date — while buyers got the time needed to pay off their balances.

Growing demand for supply chain finance

Returning to a new normal, the demand for supply-chain finance programs continues apace among suppliers and buyers alike because of their interdependence and ability to enhance relationships with trade partners. Lessons learned from previous financial crises point to the necessity for maintaining supply chain integrity, and ensuring that suppliers have access to liquidity in order to produce goods and services. Suppliers found value in enlisting in these programs to use the cash from receivable conversions as working capital. And the demand continues today.

The sale of receivables provides suppliers with an alternative and efficient source of liquidity—particularly in this post-pandemic environment—that helps them optimize the capital they use for day-to-day operations. Suppliers can then use their credit facilities for alternate financing purposes other than working capital, like expansion or capital improvement, for example.

From the buyer’s perspective, they are equally concerned about suppliers’ solvency, because their businesses are reliant on a smoothly functioning supply chain with no interruption. The number of buyers enlisting their suppliers in supply-chain finance programs also increased as a consequence of the pandemic.

A buyer-led program links a single buyer with multiple suppliers, automating transactions and tracking invoice approval and settlement processes—from initiation to completion—between the buyer and the supplier. In a buyer-led program, the buyer agrees to approve its suppliers' invoices, which are then sent to a banking partner that may provide the supplier with early payment. Conversely, a supplier-led program links a single supplier with multiple buyers in a similar fashion.

The cost of hedging against disruptions in a supply chain

The potential failure of a supplier to deliver goods needed can impact a buyer’s ability to deliver their own goods to market. Historically, buyers looked for safeguards in one or two places: by holding more inventory or working with a greater number of suppliers.

For example, a buyer could stockpile a reserve of goods to be used in case of a supply shortage, or expand its network of suppliers to reduce reliance on any given one. But both options can be expensive. There are storage costs for holding inventory. And the more suppliers a buyer uses, the fewer price efficiencies the buyer can achieve. Distributing an order for 100 widgets across 10 suppliers, for instance, would likely cost more per widget than consolidating the order with just a handful of suppliers, who might be able to reduce the price per widget as they manufacture more due to economies of scale.

Buyers place a premium on the individual solvency of each supplier; yet may occasionally need to diversify suppliers by geography in case of regional disruptions having nothing to do with solvency. Some buyers faced supply shortages as factories near and far closed during the height of the pandemic. Now, we are seeing clients assess their dependence on any one region, and create workarounds with other suppliers to avoid bottlenecks in similar future situations.

The impact of optimizing working capital

As the focus returns to optimizing working capital, we are seeing investment analysts closely tracking working capital metrics. While each company is different, and their needs and objectives are different, a successful supply chain finance program can drive an improvement in those metrics. For one company, the focus may be on balance sheet improvement, where the impact of a supply chain finance program can result in significant gains. Others may be focused on Income Statement improvement, where ancillary supply chain solutions like dynamic discounting could play an important role. Or a combination of multiple solutions may help the CFO and Treasurer glean the most value from their financial supply chain to their physical supply chain in support of corporate social responsibility efforts.