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Dynamic Discounting vs. Supply Chain Finance

by Richard Pollina

March 31, 2022

Despite the fact that the two are fundamentally distinct, dynamic discounting and supply chain finance have several similar characteristics. 

Dynamic discounting and supply chain finance are two terms that are frequently used interchangeably. However, dynamic discounting and supply chain finance are commonly seen as different solutions even though they are both early payment solutions used by a buyer.

It can be pretty complex when deciding which one to employ as part of a working capital plan. This article compares dynamic discounting with supply chain finance to help you make the right decision when it comes to choosing one among the two methods.

What is dynamic discounting?

Dynamic Discounting refers to both the method and the technological systems that allow buyers and suppliers to modify standard payment terms. The core concept behind Dynamic Discounting is that the buyer offers to pay the supplier earlier in exchange for a predetermined discount depending on particular buyer-specified parameters.

The suppliers are given a discount rate dynamically depending on how many days earlier the payment is made. It enables suppliers to achieve a perfect balance between costs and payment deadlines. The earlier payment is made, the higher the discount. The buyer typically sponsors dynamic Discounting systems.

What are the benefits of dynamic discounting?

  1. Buyers can strengthen their relationships with suppliers by providing early payment and access to a user-friendly system.
  2. The most significant financial advantages for the buyer are the exclusive discounts obtained. There is no float or rise in Days Cash on Hand (DCOH), but the buyer receives the whole amount of the values.
  3. Suppliers can pick which invoices to accelerate and when they want to be paid using dynamic discounting.
  4. Suppliers can improve their cash conversion cycle by receiving early payment, which lowers their day’s sales outstanding (DSO).

What are the disadvantages of dynamic discounting?

  1. suppliers who participate in a dynamic discounting system agree to lower their prices and, as a result, face a minor blow to their profitability. This can sometimes affect small-scale suppliers. Therefore suppliers should analyze their financial health to ensure that they can sustain in the dynamic discounting system.
  2. The banks also take a hit due to dynamic discounting. The unexpected withdrawal of money caused by dynamic discounting makes it challenging for banks to forecast their liquidity needs.

What is supply chain finance?

Supply chain finance (SCF) includes a third-party financing source, in contrast to dynamic discounting, which the buyer’s extra funds back. SCF/reverse factoring is often a bank-funded service that provides early payment to suppliers. When the invoice matures, the buyer merely deposits the funds into the bank’s remit-to account.

One prevalent type of SCF involves a supplier selling receivables at a discount to a bank or other financial institution as soon as the buyer confirms the payment. The third party will purchase the receivable at a discount from the supplier and receive the entire payment from the buyer on the original maturity date.

What are the benefits of supply chain finance?

  1. SCF improves cash flow by enabling buyers to streamline supplier payment terms while also allowing suppliers to be paid ahead of schedule. As a consequence, both the buyer and the supplier benefit.
  2. Buyers can boost working capital and retain cash for more extended periods by paying later. This allows them to fund critical development and financial activities such as innovation, debt reduction, and transformation.
  3. Similarly, the suppliers get increased operating cash flow, which allows them to spend on development and business health areas.
  4. Suppliers get near-immediate payments in return for prolonging payment terms (for example, from net 30 to net 90), and as a consequence, they can better estimate future cash flow.

What are the disadvantages of supply chain finance?

  1. Banks (and specific third-party funders) begin supply chain financing contracts with large suppliers exclusively as it makes more financial sense for them. Therefore, small suppliers who would benefit the most cannot use supply chain finance.
  2. As ineligible suppliers will not receive financial help and will have to wait substantially longer to be paid, supply chain finance may negatively affect the supply chain and supplier relationships.

Final thoughts – Which one to choose?

Supply chain finance is typically only available to near-investment-grade companies, although dynamic discounting is available for all official electronic invoices. Nevertheless, both early payment solutions aid in the provision of working capital, the improvement of trade conditions, and the maintenance of excellent supplier relationships.

Sometimes the cons of one might outweigh the pros of the same, depending on your usage and requirements. Therefore, the ultimate decision of choosing between dynamic discounting and supply chain finance is in your hands and depends on your needs. Of course, you can also opt to use both of them.