If a buyer offers you early payment on invoices, you may wonder how supply chain finance differs from factoring. In short, supply chain finance is a broad family of techniques; factoring is one technique within it.
This explainer belongs to the wider topic of small business finance, which covers the other ways firms manage cash flow.
| Item | Value |
|---|---|
| Standard definitions first published | 9 March 2016 |
| Core techniques defined | 8 techniques, plus the Bank Payment Obligation as an enabling framework |
| Associations in the joint initiative | 5 associations: ICC, BAFT, EBA, FCI and ITFA |
| Global Supply Chain Finance Forum established | 2014 |
| Update announced | January 2021, adding a sub-category with 3 techniques |
These figures come from the ICC announcement and a BAFT policy news post. Dates, definitions and terms can change, so check the source before you rely on them.
What does supply chain finance mean?
Industry associations define supply chain finance (SCF) as the “use of financing and risk mitigation practices and techniques to optimise the management of the working capital and liquidity invested in supply chain processes and transactions”, according to the ICC Academy. In plain terms, it is a label for a group of ways to fund the gap between delivering goods and getting paid.
The same definition adds three features:
- SCF is typically applied to open account trade.
- It is triggered by supply chain events.
- The finance provider must have visibility of the underlying trade flows, which a technology platform can enable.
Open account trade is where a seller delivers first and the buyer pays later. Background on those payment terms sits in the explainer on what is trade credit.
Where factoring sits among the standard techniques
The Standard Definitions for Techniques of Supply Chain Finance were launched on 9 March 2016 by a joint initiative of the ICC Banking Commission, BAFT, the Euro Banking Association, Factors Chain International and the International Trade and Forfaiting Association, per the ICC. They describe eight core techniques and treat the Bank Payment Obligation as an enabling framework.
The contents page of the 2016 definitions document shows where factoring sits:
- Receivables Purchase category: receivables discounting, forfaiting, factoring, factoring variations and payables finance.
- Loan or advance-based techniques: loan or advance against receivables, distributor finance, loan or advance against inventory and pre-shipment finance.
Factoring is therefore a member of the SCF family, not a separate field. The document also has a master definition of supply chain finance that sits above every individual technique.
Key differences between supply chain finance and factoring
A 2012 piece in The Global Treasurer, dated April 5, 2012, compares the two. It notes that the most common form of SCF is the financing of receivables after the buyer has acknowledged the debt, and the table below sets out its contrast with factoring.
| Aspect | Factoring | Buyer-centric SCF |
|---|---|---|
| Shape of the arrangement | Based on a portfolio, or a one (supplier)-to-many (buyer) approach | Follows a many (suppliers)-to-one (buyer) concept |
| Single-debtor capacity | By default limited for factoring companies | Exceeds those limits by far; banks are equipped to manage large amounts of debtor risk |
| Place in the 2016 definitions | One technique, in the Receivables Purchase category | The master definition covering all techniques |
The comparison draws on The Global Treasurer and the 2016 definitions document. Terms vary by provider and country, so check the sources before you rely on them.
In the buyer-led version, the bank acts as paying agent for the suppliers, which the same article says basically eliminates collection risk on the financed receivable. It adds that this makes any credit assessment of the suppliers basically redundant, because the only relevant risk is the buyer’s default.
Reverse factoring is different, the article argues. It is in general unable to completely eliminate the need for a risk analysis on the supplier side, and it often leaves the financier with a remaining servicer’s risk tied to collection activities in the supplier’s hands.
BAFT’s policy news post describes the buyer-led Corporate Payment Undertaking (CPU). Sellers in the buyer’s supply chain can, at their option, request a discounted early payment, and unlike in payables finance the provider does not purchase the underlying receivable but relies on the buyer’s irrevocable payment undertaking.
Why the terms still get mixed up
The Global Treasurer’s April 2012 article called the use of the term “reverse factoring” in the SCF context one of the most recurrent sources of confusion. The Global Supply Chain Finance Forum was established in 2014 to develop and champion commonly agreed market definitions, according to BAFT’s January 2021 post.
Part of the problem is how the market grew. The ICC Knowledge 2 Go description says SCF propositions have evolved at different rates and in varying directions by region and at the level of individual providers. It also calls the definitions a “living document” that will require periodic updating.
The BAFT post shows that process at work. As of its January 2021 date, the Forum had announced a new Advanced Payable sub-category with three techniques: Corporate Payment Undertaking, Dynamic Discounting and Bank Payment Undertaking, with a final updated master document to follow once the description series was published.
Names can also blur at the earlier stages of a deal. The Global Treasurer’s April 2012 article says the most advanced SCF solutions can start from a confirmed purchase order and trigger a pre-shipment finance loan, which is a neighbour of purchase order financing.
Costs and risks to understand
The sources used for this page do not quote fees, rates or funding times. Those depend on the provider and the country, so any figure you see elsewhere should be read against its own dated source and written terms.
The sources do point to several risk questions:
- Dependence on the buyer: in buyer-centric SCF the only relevant risk is the buyer’s default, and large programmes are mainly built around an investment-grade corporate client.
- Supplier-side risk in reverse factoring: the financier may keep a servicer’s risk linked to collections.
- Single-debtor limits: factoring companies are by default limited in how much exposure to one debtor they can take.
- Optional participation: in a Corporate Payment Undertaking, sellers can request early payment at their option rather than by obligation.
Accounting is a separate subject. The 2016 definitions document includes a note on the accounting and regulatory capital treatment of supply chain finance, which signals that the treatment is not covered by the technique definitions themselves.
Frequently asked questions
Is factoring a type of supply chain finance?
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Under the 2016 standard definitions, yes. Factoring appears as a technique within the Receivables Purchase category, alongside receivables discounting, forfaiting and payables finance.
What is reverse factoring?
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The Global Treasurer’s April 2012 article describes it as sharing a few defining characteristics with the most common form of SCF, including that the transaction is disclosed and the buyer is asked to confirm the invoices. It adds that reverse factoring generally still needs a risk analysis on the supplier side.
Does supply chain finance only apply to international trade?
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No. The 2016 definitions document says the form of financing applies equally in support of domestic and international supply chains.
Who wrote the standard definitions?
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The Global Supply Chain Finance Forum, made up of BAFT, FCI, the ICC, ITFA and the Euro Banking Association, as described in BAFT’s January 2021 post. The ICC announced the first set on 9 March 2016.
This page is for general information and education only and is not financial, investment, tax or legal advice.
