One way that a company can make itself look more attractive financially is by not paying suppliers quickly. For example, rather than paying suppliers at the time of delivery of a raw material, the customer might wait and pay 60, 90 are even 180 days after receiving the material. This is a sneaky way that a company can inexpensively save cash by delaying payment of suppliers until after payment is made for the item that the suppliers material is used.

The problem is that this hurts their suppliers cash flow. The suppler may need to borrow money, using their accounts receivable as collateral, in order to continue doing business. This type of accounts receivable borrowing is commonly done, and it can be a significant expense, especially if the company is small.

Flipping this to the customer and paying suppliers quickly is often a good practice since it improves the suppliers cash flow and makes them financially stronger. The practice of using short term loans, say six months to a year, to finance these payments to suppliers has become know as “supply chain finance.” When short-term interest rates are very low, as the are today, this can be an attractive practice that allows a company to preserve cash for more attractive investments (such as buying back stock, buying new production technology, and investing in research).

One risk is that banks or other lenders my stop financing accounts receivables when a company begins to struggle due to a turn down in demand. So when the company needs cash liquidity the most, the company is forced to use it’s own cash to pay suppliers. This can result in a financial crisis for the customer and the supplier.

Supply chain finance allows a company to pay suppliers quickly, This gives the supplier incentive to make quick deliveries and to be responsive to customer needs. Further, if it is the supplier that is struggling this is a tool to increase the cash liquidity of the supplier.