PETER JACOBSTEIN, Chief Strategic Partnership Officer, The Interface Financial Group

January 14, 2020

Buyer-led early payment programs are growing fast.  Fully 55% of companies surveyed in PWC’s 2018/2019 Supply Chain Finance Barometer are running some form of early payment program.  Broadly, as Buyers extend their payment terms, offering early payment is a critical part of maintaining a healthy, happy supply chain.

Today we’ll look the two most common types of Buyer-led early payment, and how each manages the risks involved.

What’s Buyer-Led Early Payment?

First a quick reminder of how Buyer-led early payment solutions work:

• • Dynamic Discounting:  The Buyer offers its Suppliers early payment of Confirmed Invoices (approved and scheduled for payment) in exchange for a discount.  It’s “dynamic” because the discount is calculated daily based on the number of days of early payment.
    
    

• • Digital Supply Chain Finance:  This program differs from Dynamic Discounting in one key detail:  a third-party funder (rather than the Buyer) provides the early payment to the Supplier.  This is commonly used when Buyer wants to provide an early payment opportunity for Suppliers, but can’t or doesn’t wish to deploy its own capital.  This situation is more common than you might think.  It’s estimated that corporate buyers have excess capital to meet just 6%-10% of demand for early payment.
    
    

With Digital Supply Chain Finance, the funder pays the Supplier on the date requested, captures the discount, and is paid back in full by the Buyer with the invoice is paid.

What’s the Risk?

With both these programs, the Supplier’s invoices are Confirmed – approved by the Buyer and scheduled for payment.  So where’s the risk?

For Dynamic Discounting, the consensus is there isn’t much of any.  Why?  Because this is simply a Buyer paying its own Supplier…just earlier than planned.  The Buyer has full information on the Supplier, the goods or services it received, and any other data related to the transaction.

In the case of Digital Supply Chain Finance, however, there is risk for the third-party funder.  After all, that funder pays the Buyer’s Supplier (less only a small discount) and must then wait for payment in full from the Buyer.  If that payment doesn’t come – or is made in less than the full invoice amount – the funder comes up short.

There are a number of reasons that a Confirmed Invoice might not be paid in full by a Buyer.  Chargebacks, setoffs, taxes, disputes, and liens are just a few.  These might not even pertain to the invoice paid early by the funder — but those deductions could nonetheless be taken against payment of the funder’s invoice.  Taken together, these constitute what’s known as Post-Confirmation Dilution — deductions from a confirmed invoice that could result in less than full payment on the payment date.

How to Manage the Risk?

Any third-party funder of early payments can be subject to the risk of Post-Confirmation Dilution.  What’s needed is a strategy to manage it.  Here’s how major players in the Supply Chain Finance industry handle risk.

• Banks: By far the largest providers of Supply Chain Finance, banks are also the most conservative funders. They are generally bound by tight bank risk policies, and control access to funding in order to manage risk.  Bank funding is typically available to investment-grade and near investment-grade Suppliers.  Bank risk is reduced, but so is smaller Supplier access to working capital.

• Non-Bank Funders: Bank restrictions on funding can leave small- and mid-sized Suppliers without access. A number of non-bank funders have grown to fill this gap.  Unbound by strict bank lending policies, these companies can provide working capital as needed.

However, these funders also face dilution risk, and still need a way to protect themselves.

The solution most of the non-bank funders have arrived at is a Buyer Guarantee.  The funder requires that the Buyer guarantee payment in full on any invoices the funder pays early. In this way, the funder can be assured that they will receive all funds due. The Buyer guarantee is often called an Irrevocable Payment Undertaking (IPU).

However, there are two big drawbacks to this approach:

• Buyers dislike being forced to guarantee payment of invoices in full, as it ties their hands.

• When a Buyer guarantees payment, there are potential accounting treatment issues. A trade payable that has been guaranteed may be subject to reclassification as debt – with balance sheet implications.  All of the Big 4 accounting firms are looking at this issue now.
  
  

Another Approach?

Some SCF providers are exploring new ways of managing risk, without limiting Supplier access or requiring Buyer guarantees. IFG is leading the way, with a system that uses deep dilution analysis, reviews of external data like credit, liens, taxes, behavior data in combination with machine learning — and without asking Suppliers to provide any related information. The result is instant access to real-time funding for virtually every Supplier, delivered online.

Bottom Line

Any entity that funds the early payment of invoices takes on risk – even when the invoices are approved and scheduled for payment.  If you’re considering Supply Chain finance, it’s vital to understand how your funding partner will choose to manage risk – and the downstream implications of that risk management for your business.