Supply chain finance vs letters of credit vs factoring: which is right for a commodity trader?

By Saurabh Goyal, Founder & CEO of Phlo Systems. Published 28 June 2026.

A commodity trade ties up cash from the day you pay your supplier to the day your buyer pays you, and that gap can run sixty, ninety or more days. Financing that gap is the single biggest lever on a trader's return on capital. The trouble is that the three instruments most traders reach for, letters of credit, factoring and supply chain finance, are routinely lumped together as "trade finance" when they solve genuinely different problems. Choosing the wrong one quietly caps how much you can trade.

The 30-second answer:

• A letter of credit (LC) is a payment guarantee from a bank. It de-risks a transaction between parties that do not trust each other. It is not primarily a working-capital tool.
• Factoring sells your receivables (invoices owed to you) to a third party at a discount, so you get cash now instead of in 90 days.
• Supply chain finance (SCF) funds the gap across the whole cash cycle, often on the buyer's stronger credit, so suppliers get paid early without the trader carrying the cost on its own balance sheet.
• For a growing commodity trader, SCF usually scales working capital better than stacking LCs or factoring invoice by invoice.

Letters of credit: a trust instrument, not a funding line

An LC is a bank promising your counterparty that payment will be made once documents prove the goods shipped. It is invaluable when you are trading with a new or distant counterparty and neither side wants to move first. But an LC ties up your bank facility, carries issuance and amendment fees, and is slow and document-heavy. It solves counterparty risk. It does not, on its own, free up cash to do the next trade. Many traders discover their growth ceiling is really their LC line.

Factoring: turning invoices into cash, at a cost

Factoring sells the invoices your buyers owe you to a financier who advances most of the value immediately and collects later. It converts receivables into cash and can be quick. The trade-offs: it is priced on your credit and your buyers' credit, the discount can be steep, and recourse factoring leaves you on the hook if the buyer does not pay. It is a useful patch for a lumpy receivables book, but it is transactional and rarely the cheapest way to fund a steady, growing flow of trades.

Supply chain finance: funding the whole cycle

SCF is the broadest of the three. Rather than de-risking one transaction or discounting one invoice, it finances the working-capital gap across the chain, frequently anchored on the credit of the strongest party in the chain. Suppliers get paid early, buyers keep their terms, and the trader is not forced to carry the entire funding cost on its own balance sheet. For a commodity trader whose constraint is "how much can I finance at once," SCF is usually the instrument that scales, which is precisely why it sits at the centre of how a modern trade-finance platform thinks about a CFO's problem.

Side by side

	Letter of credit	Factoring	Supply chain finance
Problem solved	Counterparty / payment risk	Slow receivables	Working-capital gap across the cycle
What moves	A bank guarantee	Your invoices, sold at a discount	Funding along the chain
Priced on	Your bank facility	Your + buyer credit	Often the anchor party's credit
Speed	Slow, document-heavy	Fast	Fast once set up
Scales with volume	Poorly (ties up the line)	Transaction by transaction	Yes, as a programme
Best for	New / untrusted counterparties	Patching a lumpy book	Funding steady, growing trade flow

How to choose

Match the instrument to the problem, not the habit. If the real issue is that you do not trust the counterparty, an LC earns its fee. If you have a one-off cash crunch from a few large invoices, factoring bridges it. If the constraint is structural, you cannot fund enough trades at once to grow, SCF is the tool that lifts the ceiling. Most growing traders end up using more than one, but defaulting to LCs for everything is the most common and most expensive mistake.

Frequently Asked Questions

What is the difference between a letter of credit and supply chain finance?

A letter of credit is a bank guarantee that de-risks payment between two parties that do not fully trust each other. Supply chain finance funds the working-capital gap across the trade cycle, often on the credit of the strongest party in the chain. One manages counterparty risk; the other manages liquidity and scale.

Is factoring cheaper than supply chain finance?

Not usually for steady, growing volume. Factoring is priced on your and your buyers' credit and discounts invoices one at a time, which gets expensive at scale. Supply chain finance, run as a programme and often anchored on a stronger credit, typically funds growth more cheaply.

Which trade finance instrument is best for a commodity trader?

It depends on the problem. Use an LC for untrusted counterparties, factoring for a lumpy receivables book, and supply chain finance to scale working capital across a growing flow of trades. Many traders combine them, but SCF is usually the one that removes the growth ceiling.

Does supply chain finance go on the trader's balance sheet?

Often it does not sit entirely on the trader's balance sheet, because the funding can be anchored on the buyer or another strong party in the chain. That is a large part of why SCF scales better than carrying every trade on your own facility. Treatment depends on the structure and on current accounting disclosure rules, so confirm with your finance team.

How Phlo Systems helps

finPhlo is trade finance and finance intelligence built for commodity-trader CFOs. Rather than treating every trade as a fresh LC application, it manages working capital across the whole cash cycle and gives the CFO a live view of liquidity, exposure and funding cost. If your trading volume is capped by your bank line rather than by demand, talk to finPhlo about a supply-chain-finance approach.

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Related reading:

• The cash flow implications of hedging commodity positions with futures
• Best Trade Finance Software for Commodity Trader CFOs in 2026

Saurabh Goyal is the Founder & CEO of Phlo Systems. He has built finance and trading systems for commodity houses since 2008.