Reverse factoring is a type of supplier finance solution that companies can use to offer early payments to their suppliers based on approved invoices.
Suppliers participating in a reverse factoring program can request early payment on invoices from the bank or other finance provider, with the buyer sending payment to the financial institution on the invoice maturity date.
By giving suppliers access to reverse factoring, buyers can reduce the risk of disruption in their supply chains and strengthen their supplier relationships, while also improving their own working capital position.
Reverse factoring is also widely known as supply chain finance, although the term ‘supply chain finance’ is also occasionally used as an umbrella term to include a range of supplier financing solutions.
The term ‘reverse factoring’ differentiates this form of finance from factoring, another type of receivables finance in which a company sells its invoices to a factor at a discount. The company’s customers will then send payment for their invoices to the factoring company.
With a reverse factoring solution, the program is initiated not by the supplier but by the company which is purchasing goods or services (the buyer).
Consequently, the interest rate charged by the financial institution is based on the buyer’s credit rating instead of the supplier’s, which typically results in a lower cost of funding than the supplier could otherwise achieve.
The process starts when a supplier wants to take advantage of the available funding on their invoices.
The supplier will apply for early payment at the bank, and the bank will confirm the terms and conditions of the program.
One of the key differences between reverse factoring and other types of supplier finance is that with reverse factoring, the supplier is paid at the same time they would typically receive the payment from the customer.
This is called ‘real-time funding.’ The supplier then sends the invoice to the buyer and requests that they be paid early.
The buyer pays the invoice and the bank credits the funds to the buyer’s account. The buyer then pays the bank the full amount of the invoice plus the finance charge.
Reverse factoring helps suppliers manage their cash flow by providing them with access to funding on their outstanding invoices. This can help suppliers avoid being short on cash, which may lead to supply chain disruptions.
By offering suppliers the option of early payment, buyers can help strengthen their supplier relationships as suppliers have a greater incentive to provide a high level of service.
For example, a supplier that is having difficulty being paid by its customers could use reverse factoring to be paid by its buyer in as little as 30 days.
In addition, a supplier may be able to negotiate a lower interest rate on the reverse factoring line of credit than they would be able to obtain from a bank or other financial institution because reverse factoring is provided as a service to the buyer.
Buyers see a reduction in their working capital requirements by paying off invoices earlier than they otherwise would.
However, unlike with early payment options such as a letter of credit or a banker’s acceptance, the buyer does not need to deposit collateral or have a large balance sheet.
By offering reverse factoring as a service to suppliers, buyers can retain their established suppliers. This can benefit both sides as it could increase their working relationship and result in an increase in future orders.
If a buyer has a large amount of outstanding invoices, it may struggle to find a bank willing to provide them with additional credit. But by providing early payment to suppliers, a buyer can reduce the amount of credit it needs.
Reverse factoring and dynamic discounting are both types of supplier finance solutions. Both are designed to help suppliers improve their cash flow.
But while reverse factoring sees buyers paying suppliers in advance based on approved invoices, a dynamic discounting program offers an incentive to suppliers to offer early payment.
For example, a buyer may offer a supplier an incentive of 0.5% off their next invoice if the supplier pays that invoice within 10 days.
With dynamic discounting, the seller has the option to accept or reject the terms of the program. With reverse factoring, however, the terms are set by the financial institution.
Reverse factoring is used by many large companies that purchase goods or services from a number of smaller suppliers. These businesses can’t wait until their customers have paid their invoices, so they use reverse factoring to fund their payments.
The benefits of reverse factoring for buyers and suppliers make it an attractive option. The following companies use reverse factoring:
Retailers: These companies often need to make fast payments to their suppliers to stock their stores with the right inventory.
Manufacturers: Companies that make products to sell to retailers use reverse factoring to pay their suppliers.
Logistics companies: These businesses need to pay their suppliers on time to ensure their customers get the products they’ve ordered.
In a reverse factoring scenario, the buyer pays for the service. The financial institution is compensated for the risk it takes with interest, as well as other administrative fees. The amount the financial institution charges is based on the buyer’s credit rating.
The rates charged are typically higher than what suppliers can get from other types of supplier finance such as a letter of credit.
However, suppliers have a higher incentive to provide a high level of service due to the fact that they are being paid earlier than normal.
Reverse factoring programs can come with additional costs for both buyers and suppliers. Suppliers may have to pay a setup fee, an application fee, an administrative fee, and/or a monthly fee. Buyers often have to pay a setup fee, as well as a monthly fee.
Reverse factoring is a useful tool for invoices financing, especially for smaller suppliers or companies that don’t have a history of timely payment. It’s also a good option for buyers that have a difficult time getting funding from a bank.
Buyers can also use reverse factoring as a way to reduce their working capital requirements. Suppliers also have the added benefit of being paid earlier than normal, which can help them stay on track with their cash flow.
This type of financing is also beneficial for suppliers, as it gives them more incentive to provide a high level of service to their customers.