Value Chain Glossary: Value Chain Finance
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Value Chain Finance
Refers to financial products and services that flow to or through any point in a value chain in order to increase returns on investment and growth and competitiveness, of that value chain. Access to finance for actors in a subsector can affect the level of competitiveness of the entire value chain. Value chain actors themselves, banks, microfinance institutions, other non-bank financial institutions, or a combination of these actors can provide finance to a value chain.
Some value chain actors finance others in the value chain as a means to off-set potential risk. For example, a buyer may provide working capital loans or advances to farmers to ensure the timely delivery of a final product. Their incentive to lend is not the profitability of the loan itself but securing the delivery of a promised good. Traders can provide in-kind loans (in the form of inputs) to farmers as a normal business practice with clients that have limited liquidity. The trader’s goal may be to build trust and a stable client market, or the trader may recognize that obtaining inputs on credit is the only way the cash-strapped farmer will be able to make the purchase. A microfinance institution or bank may provide finance to a particular value chain as part of a larger strategy to diversify their portfolio and lower overall risk due to the downturn in one sector versus another. In addition, a producer is in effect, providing financing to a buyer by delivering their products and trusting that payment will be received once the buyer herself or himself has been paid. Lines of credit, factoring and warehouse receipts financing are other forms of value chain finance.
Value chain finance is important to help businesses meet market demands – whether that be to maintain or expand operations or invest in upgrading to access new market opportunities. For example, a farmer may borrow against a warehouse receipt to purchase a new tractor; a shoe maker may take a forward contract to produce a new line of shoes; or an industrial tire manufacturer may access a line of credit in order to increase production to meet a lucrative order under a tight deadline. These examples show the importance and flexibility value chain finance offers. And, as a result of close working relationships (e.g., between buyers and suppliers), actual or perceptions of risk are decreased, and loans or input supplies are provided more readily than without this intra-chain information. So while financing might still come from traditional sources, it is based on value chain relationships or information.
Value chain finance works best where the value chain is functioning well; that is where there is strong end market demand, as well as transparency, trust and strong and repeated inter-firm transactions. The stronger the relationships, the more readily players in the value chain can rely on their relationships to facilitate access to finance.
