The world has witnessed a host of technological innovations and developments in the last few decades. Just in Time Financing is one such technology enabled ideas.
When one thinks of technological advancements, the first things that come to mind are smartphones, TVs, and other gadgets. The impact of electronic gadgets on human life is well-documented, but the effect of other equally important innovations has gone unnoticed like the advancement in global supply chains and financing.
The modern economy is supported by a complex network of global supply chains. A bulk of the products we use carry parts from multiple countries. Dynamic supply chains have made it possible to manufacture the product cheaply in a country and ship it to another country thousands of miles away for consumption. Efficient supply chains are a result of an advanced manufacturing and financing system. Manufacturing has undergone a drastic change, but the transformation of trade finance had been slow till a few years ago.
The rising penetration of the internet and the availability of credible data has simplified trade finance. A number of new models have been introduced that are likely to spend the entire financing industry. One of the most promising practices is just-in-time financing.
The existing system
To understand just-in-time financing, one will have to get an idea of how global trade functions currently. Global trade largely runs on a financial instrument known as the Letter of Credit.
Banks issue letters of credit to importers. It guarantees that the seller will be paid by the buyer if the goods received are as per the specifications agreed upon. If the buyer is unable to pay, the bank completes the payment to the supplier. The credit letter has become a crucial instrument due to the complexities of global trade like distance and different laws. The entire process behind the issuance of a letter of credit and the processing of the payment is cumbersome. On one end buyers seeking letters of credit have to provide a variety of documents, while on the other end the suppliers have to wait for several days for the payment to reflect in their accounts. The letter of credit system requires complex coordination between buyers, sellers, and their respective banks.
What is Just in time Financing?
In contrast, just-in-time financing is fast, efficient, and simple. It does not require an exchange of physical documents between banks, exporters, and buyers. Just in time financing is an internet-based financing system that uses the available data of buyers and suppliers for credit assessment and financing. In the case of traditional financing instruments, the suppliers’ capital remains trapped in the system for a long time due to the cumbersome process of ensuring the genuineness of various documents, including the purchase order.
Just-in-time financing ensures that suppliers do not have to wait for their capital for several days or even months. Not having access to capital increases the cost of business. By just reducing the time between the delivery of products and payment, just-in-time financing reduces the cost of capital for businesses. A number of new-age fintech companies like CredAble are at the forefront of the revolution in supply chain financing. Though the broad contours of different just-in-financing products are similar, there are slight variations in the final offering. Some fintech companies offer to fund even before the invoice is generated based on the past supply milestones, while others require an invoice to process payment.
Why is Just in time Financing needed?
The benefits of just-in-time financing do not need elaboration, however, certain changes in the global supply chain have given a fillip to the adoption of the system.
Increasing credit cycles: The business cycles of large importers and exporters stretches into months. Large buyers generally ask for longer payment windows. A typical order cycle can take up to over 70 days from the initiation of the order to the completion of the payment. The order is executed within a couple of weeks and the invoice is raised, but the payment may take up to 60 days. Essentially, the suppliers’ credit gets locked for over two months. Just-in-time financing helps in filling up the gap between the execution of the order and the payment. It unlocks capital when it is needed the most.
Use of just in time manufacturing: An increasing number of companies are adopting lean manufacturing techniques like just-in-time manufacturing. It entails maintaining minimum inventory and manufacturing in small batches as and when the demand arises. To support just-in-time manufacturing, companies need a large number of vendors who are ready to supply on short notice. If a company suddenly needs to replenish its inventory, making payments to multiple vendors simultaneously becomes difficult. Just-in-time financing helps in taking care of situations where there is an immediate need for funds to ensure adequate raw materials.
The manufacturing and inventory management systems have transformed to reflect the needs of modern economies. However, trade financing has resisted substantial changes. With the emergence of just-in-time financing and its rapidly increasing adoption, trade financing is likely to witness a dramatic transformation.