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.
Reverse factoring can include programs provided by a single bank, as well as platforms which enable a number of different financial institutions to offer funding.
When putting in place a reverse factoring program, one important consideration is the accounting treatment: companies will need to make sure that the program is classified as an off-balance sheet solution rather than as bank debt.
How does reverse factoring work?
There are a number of steps in the reverse factoring process:
Buyer purchases goods or services from the supplier
Supplier uploads an invoice to the reverse factoring platform, with payment due on a future date
Buyer approves the invoice
Supplier requests early payment on the invoice
Supplier receives payment, minus a small fee
Buyer sends payment to the funder on the maturity date
Benefits of reverse factoring
Reverse factoring benefits both the buyer and the supplier in a number of ways.
Benefits for suppliers
Access lower cost funding. Funding is based on the buyer’s credit rating instead of the supplier’s, meaning that suppliers are typically charged a lower interest rate for funding.
Improve working capital. By receiving early payment on their invoices, suppliers can accelerate their cash flow and improve their working capital position by reducing their days sales outstanding (DSO).
Support innovation. Early payments can play an important role in enabling suppliers to invest in research and development (R&D), and expand their businesses.
Improve cash forecasting. Suppliers may benefit from having greater certainty over the timing of future payments, making it easier for them to forecast their cash flows effectively and ensure that their business decisions are based on accurate information.
Benefits for buyers
Improve working capital. Reverse factoring can also bring working capital benefits for buyers, which often set up reverse factoring programs when taking steps to increase their days payable outstanding (DPO).
Reduce the risk of supply chain disruption. Reverse factoring can reduce the risk of disruption to the supply chain, as suppliers are less likely to struggle to meet orders if they have access to early payments. Strengthen supplier relationships. Buyers can strengthen their relationships with their suppliers by providing them with a user-friendly reverse factoring program.
Improve negotiating position. Buyers that offer reverse factoring to their suppliers may also be in a better position to negotiate favorable commercial terms with those suppliers.
Which suppliers to offer reverse factoring?
There are different schools of thought when it comes to deciding which suppliers should be given access to a reverse factoring program. Traditionally, companies offering reverse factoring limited the program to their top 20 or 50 suppliers, not least because of the administrative effort required to onboard suppliers onto the program.
More recently, however, technology-powered programs have made it easier for companies to offer reverse factoring to their entire supplier base, which may run to thousands – or even tens of thousands – of suppliers. This approach can increase the benefits of a reverse factoring program, as smaller suppliers may find it particularly difficult to access affordable funding without access to reverse factoring.
Key to the success of a reverse factoring program is the ability to onboard suppliers quickly and easily. The more straightforward the onboarding process, the more likely it is that a program will see a high adoption rate.
Reverse factoring vs dynamic discounting
Reverse factoring is not to be confused with dynamic discounting, although there are similarities between the two types of program. While dynamic discounting is also a solution that enables buyers to offer early payments to their suppliers, there is an important difference: the program is funded not by an external finance provider, but by the buyer itself.
Consequently, when using dynamic discounting, the buyer offers suppliers early payment on their invoices in exchange for a discount. In this case, the buyer can deploy its own cash in order to achieve attractive risk-free returns, while supporting suppliers and reducing the risk of supply chain disruption.
Factoring is a type of receivables finance where a supplier company sells its invoices to a third-party (the factor) for cash, and the buyer then pays the factor, rather than the supplier, at the invoice due date. Reverse factoring, on the other hand, is initiated by the buyer in the transaction. The factor in a reverse factoring arrangement will pay the supplier on behalf of the buyer, who will then pay the factor back under the terms of the agreement. Both are essentially lines of credit facilitated by a third-party lender. The main difference is who is drawing on credit.
According to research from Moody’s, almost half the companies involved in the buying side of supply chain transactions use reverse factoring in some form. However, it’s most useful to those buyers who have a strong credit rating, and even then, typically only deployed in stable, long-term supplier relationships.
Under a reverse factoring agreement, the supplier who is due payment on outstanding receivables is paid by the third-party financier known as the factor. This may be a bank or another dedicated financial institution, like Taulia. The buyer in the transaction then pays the amount due to the factor, rather than the supplier, on or before the invoice due date as per the original payment terms.