This broader interpretation of supply chain finance has considerable potential. Once we move away from narrow, technique-based interpretations, we can more easily see the applications and implications of a well-thought-out supply chain finance program. Instead of thinking in terms of tools, companies can think in terms of needs, such as liquidity, risk mitigation, and balance sheet optimization. If a participant in the supply chain requires support from a trading partner in order to meet these needs, then supply chain finance can be used to help.

Capitalizing on Surplus Liquidity

One of the biggest shifts in supply chain finance in recent years has been the tendency of big companies to use their own cash to fund the program. Traditionally, a supplier would raise bank financing against invoices that the buyer had approved as part of an agreed-upon program. Now, however, firms with excess cash are finding themselves in a position to offer this liquidity directly to their suppliers.

The parties in such a transaction engage a bank to act as a facilitator, providing the IT and legal services necessary to execute the arrangement quickly and securely. This can be done through the same channels as approved payables financing, with the bank handling the contractual details of the agreement, executing payments, managing accounts, and providing a digital platform for streamlining the transaction process and on-boarding suppliers. In short, the only change from a standard supplier financing agreement is the source of liquidity.

It's a win-win solution. The supplier receives much-needed liquidity at good rates. Meanwhile, the buyer benefits from the chance to mobilize otherwise idle assets through a short-term investment opportunity with generous returns. The arrangement improves relations between trading partners, strengthens the supply chain, and demonstrates innovative thinking about supplier financing methods.

Similar techniques can also be carried out without bank mediation. A prominent example is the practice of dynamic discounting, in which suppliers agree to discount their invoices in return for faster payment from the buyer. These work on a sliding scale, with discounts increasing in line with the promptness of the payment. Again, this technique enables cash-rich buyers to use their funds to stabilize supply chains and build relationships with crucial trading partners.

Reinforcing Relationships Using BPOs

These increasingly sophisticated approaches to supply chain finance can be built upon using new digital tools such as the bank payment obligation (BPO). A BPO functions much like a letter of credit (L/C), but with enhanced digital processes. As with an L/C, the BPO sees the buyer's bank promise to pay the supplier on receipt of confirmation that the relevant contractual terms have been met. However, for a BPO, this process is executed electronically via data transfer rather than by the slower, paper-based means of the L/C.

Since its arrival in the market, the BPO has been expected to relieve companies from needing to choose between accelerating processes and mitigating risk, since it provides bank-mediated trade settlement through fast digital channels. Media focus on these valuable benefits has meant that the supply chain finance implications of the BPO have passed mostly under the radar. But the BPO is a valuable asset in supply chain finance, not just as a settlement tool, but also as a financing instrument.

Consider a supplier that offers its buyer extended payment terms, then sells the receivables to a third party in order to receive funds before the end of the extended term. This makes sense but may not be as easy as it seems, for two reasons. First, the supplier will have to pay a premium against the insolvency risk of the buyer, which will reduce the supplier's margins on the sale. And second, if the buyer has a strong credit rating, other suppliers may have already sold their receivables against that buyer, meaning that banks, factors, and other providers of supply chain financing may have exhausted their debt capacity for that particular company.

What the BPO offers is to shift the exposure associated with the receivables from the corporate buyer to the bank issuing the BPO. This eliminates both problems in one go. Since financiers have greater exposure limits for bank debt, it is easier to find a buyer with capacity for a BPO, and if the bank has a superior credit rating, that helps ensure the supplier pays only a minimal risk premium for selling the invoiced amount.

The implications of using BPOs in this respect are broad. Imagine, for example, a buyer with a long production cycle and a supplier that demands short payment terms. On the face of it, these two companies appear to be a poor match, since the supplier needs payment in a much shorter time frame than the buyer can afford, given its need to cover costs for the duration of its production cycle. Yet these companies can resolve their payment-timing differences if they use a BPO in a financing arrangement.

Using BPOs as a financing instrument, therefore, poses a neat solution to a pervasive problem, with the potential both to reinforce existing partnerships and to kindle new ones. It seems it's only a matter of time before mounting interest in the BPO hits critical mass, especially once businesses understand the full scope of its value.

Technology Can Improve Supply Chain Connections

In the meantime, technological capabilities continue to grow. The connective technology of "Industry 4.0," for instance, has the potential to make a huge difference in the way companies view and support their supply chains. This technology was first developed for the manufacturing industry, where companies use it to connect factory robots and machines to one another via the Internet. These connections enable different machines and robots to share information, communicate about irregularities, and automatically call in assistance to fix problems.

Businesses are now realizing that similar technology can be applied in the field of supply chain finance, where it can enable supply chain participants to share financial and transaction-specific data—such as the progress of goods as they are shipped around the world—via dynamic data hubs. Firms sharing these types of information can work in collaboration with one another, and with their banks and insurers, to produce sophisticated financing programs that closely match the needs of each link in the chain.

This has tremendous potential to improve the efficiency of financing programs, not least because supply chains are far more complex, and incorporate far more risks, than traditional conceptualizations suggest. Even referring to a singular supply "chain" may be slightly misleading.

In practice, supply chains are not one-dimensional, linear setups, but rather intricate networks in which each participant sells to multiple buyers and relies on multiple suppliers. Companies that leverage dynamic data hubs, and intelligent analysis of the data they collect, are in a position to master the complexity of their supply chain. For instance, a group of trading partners might establish a trigger-based financing program, whereby payments are instigated at particular stages of each transaction, based on predefined contractual terms. The arrangement could be structured so that installments are paid as certain conditions are met—conditions that all parties to the transaction agree on in advance.

The principle of trigger-based financing is not entirely new, of course. The traditional L/C requires a bill of lading to be presented to the bank before payment is made. What's new is the range of possibilities available now for monitoring almost every aspect of a transaction. Goods traveling to their destination can be monitored in great detail, so trading partners can have real-time updates of key information, such as the ship's location, whether the goods' container is still aboard the ship, and the condition of the goods (down to specifics such as the temperature the cargo is stored at). The closer goods come to their destination, the lower the risk that they will be delayed, damaged, or lost—so parties may agree to payment of installments based on reports of the progress and condition of the goods.

This is just one example of how these technologies can be used to support more sophisticated financing arrangements between buyers and suppliers. With extensive information at their fingertips, corporates are now better prepared than ever before to come to grips with the complexity of their supply chain and supply chain finance techniques' potential to stabilize the system. Of course, as with the BPO—and as with the concept of supply chain finance generally—treasurers require education to fully grasp the opportunities.

Toward a Holistic Approach

For companies to fully grasp the potential of a holistic approach to supply chain finance, treasurers must first rethink their understanding of the prospective benefits of a supply chain finance program. They should look not just at isolated metrics such as days sales outstanding (DSO), days payables outstanding (DPO), and days inventory outstanding (DIO), but also at broader benefits ranging from balance-sheet optimization and improvement of the company's overall performance against key performance indicators (KPIs) through to increased liquidity, decreased supplier default risk, and greater access to short-term investment opportunities.

Next, they must consider their current situation in terms of these issues, identifying where they are already strong, where they are lacking, and how they can use creative financing to compensate for any weaknesses. Only by building a system in which each of these issues is addressed can corporates come close to the full potential of supply chain finance.

Of course, with so many stakeholders involved—and with all stakeholders motivated by their own goals and incentives—this is easier said than done. The key is to facilitate communication between different corporate functions, including treasury, procurement, sales, and IT. The company needs to break down interdepartmental silos and encourage a collaborative approach to financing, internally as well as externally.

Evolving a company's supply chain finance program is no small undertaking, but it is surely worth it. The movement toward holistic supply chain finance operations is already under way, and increasing numbers of companies are opening their eyes to the ways in which new technologies, new techniques, and a new perspective can help them expand their reach, maximize their efficiency, and minimize their risks.

Sebastian Hölker is head of structuring and implementation of SCF products at UniCredit. Hölker is responsible for the management, innovation, and further development of UniCredit's trade products worldwide. He also handles the structuring and implementation of specific deals, with an emphasis on utilizing the latest supplier- and buyer-driven supply chain finance programs.