The historical foundation of trade finance

Trade has always required financing. From early merchant transactions to structured banking systems, businesses have relied on financial mechanisms to bridge the gap between delivery and payment.

One of the earliest and most widely adopted solutions was factoring: where suppliers sell their receivables to a third party to access early liquidity. This model provided immediate cash but at a cost, and often without addressing the broader dynamics of the supply chain relationship.

Another cornerstone of traditional trade finance was Letter of Credit (L/C), a bank-guaranteed payment instrument that provides security across borders. For decades, L/Cs dominated cross-border commerce, particularly for transactions with unfamiliar trading partners or in high-risk markets.

The rise of global supply chains

As globalization accelerated through the 1980s and 1990s, supply chains became fundamentally longer, more complex, and more fragmented. Companies shifted from local production networks to global sourcing, with 63% of large corporations today operating supply chains spanning 40 or more countries.

At the same time, competition intensified. The race to reduce costs and improve margins puts pressure on companies to optimize both operations and liquidity. Payment terms became a central lever, one that buyers increasingly pulled to their advantage.

The open account revolution

This pressure led to a fundamental structural shift in global trade: from secured, bank-guaranteed transactions to open account trade. Under open account terms, goods are shipped and delivered before payment is due, typically within 30 to 90 days.

The transition was swift and sweeping. Today, more than 80% of total world trade volume is settled on open account terms, up from a much smaller share just two decades ago. The Letter of Credit, while still used in high-risk cross-border transactions, has declined significantly as a primary payment mechanism.

Open account trade created real efficiencies, lower transaction costs, faster processing, and better buyer-supplier alignment. But it also introduced a fundamental imbalance:

  • Suppliers deliver goods before receiving payment
  • Buyers benefit from extended payment windows
  • Financial risk shifts upstream toward suppliers
  • Smaller suppliers, with less access to capital markets, absorb this risk disproportionately

The working capital implications

This shift had direct and lasting consequences for working capital dynamics across the supply chain. Buyers improved their Days Payable Outstanding (DPO), effectively using supplier credit as a form of low-cost financing. Suppliers, meanwhile, saw their cash conversion cycles lengthen and their liquidity constrained.

Recent analysis of global corporate health shows that the trend toward longer payment cycles has only intensified. By 2023, the global average Days Payable Outstanding (DPO) reached approximately 69 days, a significant increase from the 2016 average of 64.5 days. While the COVID-19 pandemic caused temporary volatility, large buyers have continued to leverage their scale to preserve cash flow. Regional variations remain stark: North America averages roughly 55 days, Europe has climbed to 66 days, and Asia-Pacific continues to lead the trend with an average of 77 days. In specific sectors like Technology and Manufacturing, it is now common to see DPO exceeding 90 to 120 days, further highlighting the growing reliance on supplier credit to bolster buyer balance sheets.

What was gained in operational efficiency was often offset by financial strain, particularly for smaller and mid-tier suppliers who effectively became financiers of the supply chain without the capital base to sustain it.

The emergence of Supply Chain Finance

Supply Chain Finance (SCF) emerged as a structural response to this imbalance. By introducing financial institutions and technology platforms into the trade relationship, SCF created mechanisms that allow:

  • Suppliers to access early payment at attractive rates
  • Buyers to maintain or further extend payment terms
  • Financial institutions to provide liquidity based on the creditworthiness of the buyer, not the supplier

This structure created a genuine win-win opportunity, one that traditional factoring and L/Cs could not achieve. By anchoring the financing to the buyer's credit rating, suppliers (even small ones) could access funding at near-investment-grade rates.

But the evolution is incomplete

While SCF addressed part of the problem, it did not fully solve it. Most SCF programs today still:

  • Focus on financing after payment terms are already set, not on whether those terms are optimal
  • Operate without visibility into what peer companies or market benchmarks actually look like
  • Rely on internal assumptions and bank recommendations rather than independent market intelligence

In other words, the industry evolved the mechanism, but not the foundation. Companies are still managing payment terms without knowing what "good" looks like in their specific market, industry, or supplier segment.

The next stage: from financing to intelligence

The next transformation in trade finance is not about new financial products. It is about intelligence, understanding what payment terms are achievable, where the opportunity lies, and which supplier relationships to prioritize.

Supply Chain Finance will remain a critical tool. But its role is evolving, from a standalone financing solution to one layer within a broader, data-driven working capital strategy. The companies that will lead are those that benchmark first, optimize terms second, and then apply financing strategically.

Frequently Asked Questions

What is factoring in trade finance?

Factoring is a financial arrangement where a supplier sells its accounts receivable (unpaid invoices) to a third-party financial institution at a discount, in exchange for immediate cash. It allows suppliers to access liquidity without waiting for their customers to pay, but typically comes at a higher cost than buyer-anchored financing solutions like Supply Chain Finance.

What is open account trade?

Open account trade is a payment arrangement where goods are shipped and delivered to the buyer before payment is made, typically within 30 to 90 days. It is the dominant structure in global commerce today, representing over 80% of world trade volume, because it reduces transaction costs and administrative complexity compared to Letters of Credit.

What is the difference between factoring and Supply Chain Finance?

Factoring is supplier-initiated: the supplier sells receivables to access cash, often regardless of the buyer's credit profile. Supply Chain Finance is buyer-initiated: the buyer anchors the program using its own credit rating, allowing suppliers to receive early payment at significantly lower rates. SCF is generally more favorable for suppliers and creates a structured, repeatable program rather than ad hoc receivables sales.

Why did the shift from Letters of Credit to open accounts create working capital challenges?

Under Letters of Credit, banks guaranteed payments, meaning suppliers had security of payment before shipping goods. Under open account trade, suppliers ship goods and carry the payment risk until the buyer's due date. As buyers simultaneously pushed for longer payment terms, suppliers found themselves financing both the delivery of goods and an extended wait for payment, creating meaningful cash flow pressure.

What is the next stage in the evolution of Supply Chain Finance?

The next stage moves beyond financing mechanisms to payment terms intelligence. Rather than simply offering financing on top of existing terms, leading organizations are now benchmarking their payment terms against market data, identifying optimization opportunities, and then applying SCF strategically. This data-driven approach, benchmark, optimize, then finance, produces significantly better working capital outcomes.

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