The current open account post-shipment, reverse factoring, trade payable discount–you name it–method for advancing a supplier funds from invoices approved for financing involves a company signing an agreement with its financial institution, or non-bank SCF provider, to create a “payment obligation” on the invoice. That is, once the company has agreed to pay the invoice, this decision is irreversible. Based on the payment obligation, the company’s bank is willing to discount the invoice and advance proceeds to the supplier, usually with a full advance rate, knowing that the company will pay the bank on the invoice payment due date.
As part of the supply chain financing programs, the company, bank or non-bank SCF provider, take care not to take any action to trigger a debt re-classification. Namely, the company can have no say in when or whether the bank provides financing to the supplier. The financing is up to the supplier to request financing from the bank. The only part the company plays is to pay the invoice on time–as it is obligated to do so.
But wait a minute. An “irreversible payment obligation” sounds a lot like a commercial letter of credit. Even though the company does not utilize a bank line of credit for the open account “obligation,” more than one company will not partake in a supply chain financing program under the payment obligation requirement. Instead, the company might agree to send a good old electronic payment instruction to the bank, with itemized invoice detail included in the payment, on or on the day following approving the invoice for payment.
The bank does not get a guaranteed payment obligation, but it does get a payment instruction that it can warehouse on its systems and execute the payment on the due date. It gets invoice detail to cull from the payment to place on a platform from which suppliers can request financing, or “sell” their receivable, to the bank. Simple. For the company, yes, it is. For bank, this process offers some challenges organizationally and technically to overcome in order to support this new model of open account supply chain finance. But, if the banks are able to get over these challenges, which we will see in the next blog post, the rewards are substantial.
