Why Supply Chain Finance Beats Trade Loans

Navigating the 'New Normal' Cost of Capital: Why Traditional Trade Loans Are Fading and Supply Chain Finance is Taking Over

Key Takeaways

The 'new normal' following the pandemic has increased the cost of capital by approximately 172 basis points on average, making traditional loans more expensive for businesses.
Supply chain finance (SCF) offers cheaper and more flexible funding than traditional trade loans, based on strong buyer credit rather than just the supplier's finances.
Companies like John Deere have used SCF to cut inventory costs and improve cash flow, showing real savings in working capital.
Switching to SCF can help firms handle higher interest rates, strengthen supplier ties, and boost overall efficiency in tough economic times.
With rising costs, SCF provides ongoing cash without strict repayment plans, making it a smart choice for modern supply chains.

Introduction

Imagine running a business where every pound you borrow feels heavier than before. That's the reality in our 'new normal' world after the COVID-19 pandemic. Interest rates have climbed, and the cost of getting money – what experts call the cost of capital – has jumped up. For many companies, this means traditional trade loans, those old-school ways of borrowing to buy and sell goods, are becoming too costly and rigid. Instead, something smarter is stepping in: supply chain finance, or SCF for short.

Let's back up a bit. Before the pandemic, money was cheap. Banks lent easily, and businesses could grow without worrying much about high fees. But then everything changed. Lockdowns shut factories, supply chains broke, and governments pumped in cash to keep things going. Now, as we settle into this 'new normal', inflation is tamed but at a price – higher borrowing costs. A study found that the average cost of equity capital for US firms rose by around 172 basis points during the early pandemic months. That's like adding extra weight to your backpack when you're already climbing a hill.

Why does this matter for trade? Traditional trade loans often rely on your own credit score and assets. If rates are high, you pay more interest, and it squeezes your profits. SCF flips the script. It uses the buyer's strong credit to fund suppliers early, at lower rates. This keeps cash flowing smoothly along the whole chain, from farmer to shop shelf.

Think about it like this: in the old days, a small supplier might wait 90 days for payment, tying up money they need now. With SCF, a bank or finance firm pays them quick, and the big buyer settles later. Everyone wins – suppliers get cash fast, buyers keep good terms, and costs stay low. In fact, with the weighted average cost of capital up by 31% for many mid-sized firms since 2020, SCF is a lifeline.

This shift isn't just talk. Big names are jumping on board. John Deere, the farming equipment giant, has slashed their cash conversion cycle to beat rivals, thanks to smart SCF programs. We'll dive into that later. But first, let's explore why the 'new normal' cost of capital is forcing this change, and how SCF is the hero of the story.

In this post, we’ll explain it in straightforward terms. We'll look at what traditional trade loans are, why they're struggling now, how SCF works, its big benefits, a real example from John Deere, and tips to get started. By the end, you'll see why ditching old loans for SCF could save your business time and money. Ready? Let's get into it.

Understanding the 'New Normal' Cost of Capital

What exactly is this 'new normal' cost of capital everyone's talking about? In simple terms, the cost of capital is how much it costs a business to get money for growth or daily needs. It includes interest on loans and what investors expect in returns. Before the pandemic, this cost was low – think cheap mortgages or easy business loans. But COVID-19 flipped everything.

The pandemic hit like a storm. Factories closed, ships got stuck, and demand for goods swung wildly. To fight inflation that followed, central banks like the Bank of England and the US Federal Reserve raised interest rates. A report shows that for American firms, the cost of equity capital – that's the return shareholders want – went up by an average of 172 basis points right after the outbreak. A basis point is 0.01%, so 172 means a 1.72% hike. That might sound small, but for a company borrowing millions, it's a huge extra cost.

Why the jump? Investors got scared. With lockdowns and uncertainty, they saw more risk in lending or investing. Firms with high exposure to COVID, like travel or retail, faced even bigger increases because their future looked shaky. Overall, the weighted average cost of capital (WACC) for mid-sized companies rose 31% from 2020 lows. This WACC is key – it's the blend of debt and equity costs, and when it's higher, businesses think twice about borrowing. In this 'new normal', high costs mean less investment. Companies hold onto cash – trillions are sitting in banks – instead of spending on new kit or hiring. Sectors like tech and real estate feel it most, as they're sensitive to rates. But for trade and supply chains, it's a wake-up call. Traditional ways of funding deals just don't cut it anymore.

Take a small exporter. In the past, they'd grab a bank loan at low rates to buy materials. Now, with higher costs, that loan eats into profits. Plus, if supply chains are delayed, they're stuck paying interest on stuck goods. This is where the 'new normal' cost pushes traditional trade loans out. They're too expensive and inflexible for today's world.

But there's hope. As rates start to ease a bit, smart finance like SCF can unlock that pent-up cash. It lowers effective costs by sharing risks across the chain. We'll see how next.

How the Pandemic Changed Everything

Diving deeper, the pandemic didn't just raise costs – it reshaped how we think about money. Before 2020, low rates meant easy growth. Post-COVID, it's about survival and efficiency. Studies show misallocation of capital jumped 40% in 2022-2024, meaning money isn't going to the best places due to higher costs and risks.

Businesses now face 'rate shock'. Managers used to cheap money are scrambling. High debt firms might benefit from refinancing later, but for now, it's tough. This all ties back to the 'new normal' cost of capital, making old finance tools like traditional trade loans look outdated.

What Are Traditional Trade Loans?

Traditional trade loans are the old faithful of business funding. Think of them as a bank giving you money to buy goods, with the deal backed by your assets or credit. They've been around for ages, helping firms import or export without upfront cash.

How do they work? You apply to a bank, show your books, and if approved, get a loan for a specific trade. Repay with interest over time. Pros: Straightforward, no need for fancy tech. But cons? In the 'new normal', they're pricey. High interest rates mean more costs, and if your credit isn't top-notch, you might not qualify.

Plus, they're one-offs. You borrow once, pay back, and start over. No ongoing flow. And hidden fees add up – things like processing or currency charges. A piece on hidden costs notes that bank rates don't show the full picture, often reducing working capital efficiency.

In short, traditional trade loans suit simple deals but struggle in complex, costly times. They're out because they don't adapt to the new normal cost pressures.

Drawbacks in Today's Economy

With costs up, these loans tie up capital. Suppliers wait for payments, and buyers face pressure. Compared to SCF, they're slower and riskier for small firms.

The Rise of Supply Chain Finance (SCF)

Supply chain finance, or SCF, is the new kid on the block – but it's growing fast. It's a way to fund the whole supply chain, not just one part. Big buyers team up with banks to pay suppliers early, at a discount, using the buyer's good credit.

How it works: Supplier sends invoice to buyer. Bank pays the supplier quick (say, in days), minus a small fee. Buyer pays the bank later, on original terms. Result? Suppliers get cash fast, buyers extend payments, and costs are low because it's based on the buyer's strength.

Why the rise? In the 'new normal', SCF cuts costs and risks. It's tech-based, using platforms for quick deals. A guide explains that it lowers costs and improves cash flow, with early payments via tech solutions.

SCF is 'in' because it fits high-cost times. It's flexible, scalable, and builds stronger chains.

Key Features of SCF

Buyer-Led: Relies on a big firm's credit for lower rates.
Tech-Driven: Apps and AI speed things up.
Win-Win: Suppliers cash in early, buyers save on terms.

Why SCF is Better Than Traditional Loans in the 'New Normal'

Here's the meat: why ditch traditional trade loans for SCF? First, cost. With capital costs up 31%, SCF uses buyer credit for cheaper funding – often lower than bank loans. No big interest piles.

Second, flexibility. Traditional loans have strict repayment terms. SCF has no schedule – it's like a revolving fund. You get capital as needed, without debt hanging over. Third, availability. Banks shy away in tough times. SCF is there when cash is tight, buying invoices directly. Fourth, ongoing support. Unlike one-time loans, SCF replenishes itself with new deals. It shares risks across the chain, making it resilient.

Fifth, better relationships. Early payments strengthen supplier ties, reducing disruptions.

Stats back it: SCF programs see zero defaults in some cases, even in high-rate times. It's cost-effective, with shared risks leading to lower fees.

In the 'new normal' cost world, SCF outshines traditional trade by being smarter, cheaper, and steadier.

Benefits in Detail

Improved Cash Flow: Consistent funds, not lumps.
Lower Costs: Cheaper than loans due to buyer credit.
Risk Sharing: Whole chain involved, less burden on one.
Speed: Quick payments via tech.
Scalability: Grows with business.

For more on SCF basics, check our internal post: What is Supply Chain Finance?

Real-World Example: John Deere's Success with SCF

Let's look at a star example: John Deere, the green tractor maker. They've mastered SCF to handle the 'new normal' cost pressures. Their story shows how switching can transform finances.

John Deere's financials are impressive. Stock at $371.98, company worth $103 billion. But it's their supply chain smarts that shine. They run a supplier financing program with banks. Suppliers get paid early via financial partners, while Deere keeps longer terms. This builds resiliency – key in pandemic times.

Take their cash conversion cycle (CCC). Over five years, it averaged 90 days, better than the industry's 125. In 2024, it's 113 days, still ahead of rivals like Caterpillar at 178. How? SCF helps. Days Sales Outstanding (DSO) – time to collect payments – averages 43 days, 40% faster than the industry's 70. Recently, 55 days, but way below PACCAR's 164. They use apps like MyFinancial for quick invoices. Inventory (DIO) at 80 days average, half the norm. Tech like GPS tractors speeds turnover.

Payables (DPO) at 33 days, quick but efficient. SCF lets them pay suppliers fast without hurting cash.

Back in 2000, under CEO Robert Lane, they restructured supply chains, cutting excess inventory in their $4 billion division. This saved on freight and assets. During COVID, they inked long-term supplier deals to avoid shortages.

Using Scrum methods, they cut cycle times by 79% and delays by 66%. Localized suppliers – 2,154 US dealers – reduce risks. Financially, they aim for the cost of goods at 20% of sales, down from 22.2%. SCF supports this by freeing capital. Deere's example? In high-cost times, SCF cut inventory drag, boosted efficiency. They beat peers in CCC by 35 days. Small firms can learn: Partner with banks, use tech for payments. But it's not all easy. They faced parts shortages but used multi-prong approaches. Still, gains are clear – stock up 12.5% in March 2024.

This shows the 'new normal' cost favors SCF. Deere's program exemplifies win-win: Suppliers happy, Deere efficient.

For similar stories, see our internal link: Case Studies in Modern Finance

External source: For more on supply chain risks, check the NIST report on Deere. And IMF on post-pandemic investment: IMF Post-Pandemic Investment

Lessons from Deere

Focus on local suppliers to cut delays.
Use tech for real-time tracking.
Partner with banks for flexible funding.

Practical Tips for Switching to SCF

Ready to make the move? Here are tips to leave traditional trade loans behind.

First, assess your chain. Map suppliers and buyers, spot cash gaps.

Second, choose a provider. Look for banks or firms like PrimeRevenue offering SCF platforms.

Third, integrate tech. Use apps for invoices – speeds everything.

Fourth, train your team. Explain the benefits of avoiding resistance.

Fifth, start small. Test with one supplier, scale up.

Tip 1: Calculate your current cost of capital – compare to SCF rates.
Tip 2: Negotiate with buyers for shared programs.
Tip 3: Monitor metrics like DSO to measure success.

For beginners, read our internal guide: Getting Started with SCF

External: Oliver Wyman on SCF opportunities: Supply Chain Finance: Riding the Waves

Conclusion

In the 'new normal' cost of capital world, traditional trade loans are fading fast. They're too costly and stiff for high-rate times. SCF steps in with flexibility, lower costs, and better flow – as seen in benefits like no repayments and constant capital. John Deere proves it works, cutting cycles and boosting efficiency.

The shift makes sense: With costs up 172 basis points and 31% WACC hikes, smart finance wins. SCF builds resilient chains, ready for whatever comes.

Ready to upgrade? Contact a SCF provider today or explore options. Your business will thank you.

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