Reverse Factoring, also known as supply chain financing, is a supplier financing solution where a company finances its receivables through an intermediary. The financial institution acting as the intermediary will pay the invoices a business owes to their supplier on behalf of the business being reverse factored.
This can help get suppliers paid faster and gives the business more time to pay back an invoice. It is offered to manufacturing, electronics, clothing, automotive, aerospace, and more companies. These industries are most actively using reverse factoring, but are not limited to these industries.
How Reverse Factoring Works
The reverse factoring process begins when a business or customer contacts a finance company or bank to be an intermediary for them. This is a three-way process between a supplier, buyer, and a financial institution. Essentially, a finance company acts as a liaison between a business and its supplier. The finance company evaluates the buyer’s creditworthiness before initiating the agreement. A supplier may request timely payments on an invoice from the finance company. The finance company will commit to paying a specific invoice or invoices to the supplier at a quick rate in exchange for a discount.
Steps in the Supply Chain Financing Process
Reverse Factoring can be done in six simple steps:
1. The buyer purchases goods from a supplier
2. The supplier would fulfill the order, then upload the invoice to a factoring platform
3. The buyer either approves or denies the invoice and agrees to pay back the institution at the maturity date of the invoice
4. If approved, the supplier may request early payment on the invoice from an intermediary finance company
5. Payment is received by the supplier, minus a small fee
6. The buyer sends payment to the financial institution.
Advantages of Reverse Factoring
Reverse Factoring offers advantages for both suppliers and buyers. Suppliers can benefit from improved day-to-day working capital for their business by receiving faster payments for their invoices, accelerating their cash flow, and incurring lower fees compared to other forms of alternative financing. It can also reduce the payment cycle for suppliers, enabling them to receive a payment within 10 days instead of the standard 30-45 days. Additionally, the fees for this financing method are typically based on the credit of the business rather than the supplier, resulting in lower costs for the supplier. Above all, buyers can enhance their working capital and strengthen their relationship with suppliers.
Factoring vs. Reverse Factoring
Both factoring and reverse factoring are used to pay invoices in a timely manner. However, in factoring, the process starts with a supplier. A supplier will sell their accounts receivable to a finance company at a discounted rate, so the supplier can get paid faster. In contrast, for reverse factoring, the buyer initiates the process and sells their account payable. A buyer pays a fee to the factor, where in traditional factoring the factor would collect from the buyer directly.