Supply chain finance is useful in many ways but is it the solution to the problem of slow payments to smaller suppliers that causes thousands of UK businesses to fold every year?
Pressure on invoice payments is a constant challenge for chief financial officers, with intense lobbying to alleviate the problem of late payment to small suppliers coupled with damage to the reputation of corporates found wanting in this regard ratcheting up the pressure on companies to pay faster.
On the face of it, supply chain finance is a solution that suits both parties: corporates can offer all their suppliers’ payment upon approval, at an inexpensive rate. At the same time, they can maintain, or often even extend, payment terms, reaping the once-off balance sheet advantages. In theory, at least, that should be the end of the story. But, according to Paul Christensen, CEO and Co-Founder of fintech firm Previse, the reality is that SCF in many cases, particularly for smaller suppliers, actually makes the situation worse, to the detriment of the whole supply chain.
He cites the latest PwC 2018-2019 Working Capital Survey, which reveals that over half of SCF programmes reach no more than 25 of the largest suppliers per buyer, and even then that is for buyers with tens of thousands of suppliers. The study also notes that 77% of SMEs experience slow payments from large corporates; and that more than a third of SMEs spend a moderate to significant amount of time and resources chasing large corporates for payment.
Certainly, with the UK Federation of Small Businesses estimating that 50,000 small firms go out of business each year as a result of slow invoice payments, the low rate of adoption of SCF noted by PwC is not for the lack of need for earlier payment from suppliers. But for Christensen, whose firm has developed a unique solution that enables algorithm-driven invoice payment decisions, the muted take-up of SCF by small suppliers actually reflects the significant administrative and technological costs of adopting it and the complexities inherent in its structure. As a result, SME suppliers – the suppliers with the most need for these programmes – are almost universally excluded from SCF programmes.
He explains that 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.”
He also points out that an SME supplier might have several large buyers, each of which are employing a different e-invoicing system and will each require a separate set of documentation for their SCF programme, generating even more complexity. “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. Put all that together and it is no wonder that the majority of suppliers, especially those most vulnerable to slow payments, are shut out of SCF programmes entirely.”
Abuse of supply chain finance
Moreover, in many instances, the inability of smaller firms to access SCF programmes run by their buyers is worse than being offered no early payment solution at all. Christensen says 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 – a scenario perfectly and scandalously illustrated last year when the post-mortem on Carillion, the failed construction giant, showed that it had rolled out SCF programmes from three banks while doubling its payment terms from 60 to 120 days.
The revelation that Carillion had used SCF – indeed an SCF scheme backed by the government – to flatter its own cash flow at the expense of its smaller suppliers led to widespread anger and raised concerns about its possible abuse by other corporates. When used like that, “SCF becomes a tool for large corporates to shield their biggest suppliers from the negative effects of extending their payment terms, the brutal impact of which falls solely on the smaller suppliers,” says Christensen.
“Clearly, that amounts to a disaster for SME suppliers with already stretched balance sheets. However, it hurts buyers at the same time too because the smaller suppliers pass on the cost in the form of higher prices, costing money which more than wipes out the gains from the extended payment terms,” says Christensen.
He explains that when a supplier accepts lengthy payment terms, their price is made up of three components, their margin and costs of production, which are in turn wrapped up with the cost of financing the gap between the 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 cash flow 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.”
Furthermore, 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.”
