What is Reverse Factoring?
Reverse factoring, also known as supply chain financing, is a three-way agreement between a supplier, the business (buyer), and the factoring company. The factoring company pays the supplier on behalf of the buyer, offering quick payments at a discounted rate.
Reverse factoring improves cash flows for both the supplier and the buyer. The supplier gets instant payment against its invoice at a discounted rate and the buyer gets more time to pay the money.
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How Does Reverse Factoring Work?
Reverse factoring works in 4 simple steps:
1 – Supplier sends invoice: After supplying the goods, the supplier generates an invoice for the buyer.
2 – Buyer sends invoice to the financial institution: After verifying, the buyer sends the invoice to the financial institution.
3 – Supply chain finance: The financial institution finances the supplier invoice at a discounted rate. In this way, the supplier gets instant cash.
4 – Buyer pays the financial institution: After the invoice has matured, the buyer pays back the money to the financial institution along with the reverse factoring fees.
Best Suited Businesses For Reverse Factoring
Reverse factoring is also termed supply chain financing because it focuses on improving the flow of funds within a supply chain, making sure that suppliers get paid more quickly. All types of businesses can opt for reverse factoring and benefit from it.
Here are some of the business sectors where reverse factoring can be helpful:
- Retailers
- Wholesalers
- Manufacturers
- Mechanics
- Restaurants
- Bars & Clubs
- Leisure Clubs
Comparing Reverse Factoring and Invoice Factoring
In reverse factoring, there are three parties involved; a supplier, a buyer, and a financial institution (bank or factoring company). In invoice factoring, there are two parties involved: a seller (business that sells invoice), and a financial institution (bank or factoring company).
In invoice factoring, a business that owns the invoices contacts a factoring company to sell its invoices at a discount. After selling the invoices, the business receives a large portion of the invoice value. The factoring company then deals with the customers to receive the pending payments. The business that sells invoices gives up all authority over its invoices and is no longer responsible for collecting money from its customers.
Note that in invoice factoring, the business that initiates the agreement mainly benefits from it. This agreement allows it to obtain cash immediately instead of waiting for the customers to pay for it.
In reverse factoring, a business wants to pay its suppliers faster. To do this, the company works with a financial institution (a factoring company). The company pays the supplier after reviewing the invoices. The business pays back the financial institution later on as per the reverse factoring agreement. In this way, the supplier gets instant payment against its invoices at a discounted rate and the buyer gets more time to pay the money.
Notice how reverse factoring benefits both the buyer and the supplier. The supplier gets paid efficiently and the buyer manages its finances easily with the help of the middle party, i.e. the financial institution.
So here’s an overall comparison to help you understand the differences better.
| Key differences | Invoice Factoring | Reverse Factoring |
|---|---|---|
|
Who initiates the agreement |
Business |
Business (Buyer) & Supplier |
|
Who benefits |
Business |
Business (Buyer) & Supplier |
|
Responsibility for collecting payments |
Factoring Company (instead of the business) |
Factoring Company (instead of supplier) |
|
Major purpose |
Access to immediate funds |
Supplier gets early payments & the business gets time to clear supplier invoices |
Benefits of Reverse Factoring
The good news is that all three parties involved in reverse factoring get something out of it.
- The factoring company, of course, gets its fees.
- The supplier does not have to wait 30 or 60 days to get its payments.
- The business gets additional time to pay back the supplier’s invoices.
Let’s take a detailed look at reverse factoring benefits:
Improved cash flow for suppliers
Suppliers receive the money for their products quickly. It improves cash flow for them. It is especially helpful for small-scale suppliers. Instead of waiting for long periods to receive money for their services, they get it in a short time.
Extended payment terms for the business
Businesses can buy more time to pay for the services of the suppliers. Since the factoring company pays the suppliers, it temporarily reduces the financial burden on the business. The business can negotiate longer payment terms with the middleman (the bank or factoring company) so they can pay back the invoices on favourable terms.
Improved supply chain stability
The reverse factor is a win-win situation for both, businesses and their supply chain partners. To put it in simpler terms, suppliers get their money quickly, so they are happy. They can manage more clients with that money.
The business can pay back the factoring company in a flexible timeline, so they are satisfied. It’s like ensuring that all the gears in a big machine work well together, so there are no unexpected stops or breakdowns.
Reduced risk for suppliers
Suppliers face less risk of late or defaulted payments since the financing institution guarantees the payment according to the agreed terms. Suppliers get their money, and the remaining financial responsibility to pay back the factoring company is completely on the business.
drawbacks of reverse factoring
While reverse factoring offers several benefits, it also comes with certain drawbacks. Let’s look at them in detail.
Higher costs
Reverse factoring can be expensive over time. The fees charged by the factoring company can add up, sometimes making it more costly than other types of financing. This can be especially tough for small businesses, where it can get difficult to manage the high costs.
Risk of financial instability
If a business using reverse factoring faces a problem like a decrease in its profits or a decrease in customer demand, it can snowball into a bigger problem. Because then, if the business doesn’t have enough funds to pay the reverse factoring provider, the provider might end the contract. This means the company now has to pay the suppliers itself and also pay back to the supplier for the previous payments. This situation can lead to a risk of financial instability and even bankruptcy.
Dependent on the buyer’s creditworthiness
The costs of reverse factoring depend on the credit score of the buyer. It means that if the buyer has a good credit score, the cost will be lower. However, businesses with a poor credit history will face higher costs. This dependence on credit rating means that companies with weaker credit ratings might not benefit as much from reverse factoring.
Impact on financial health
Using reverse factoring can increase a company’s debt. This added debt can affect the company’s financial health, resulting in a lower credit score.
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FAQs
Reverse factoring is also called supply chain financing because it focuses on improving the flow of funds within a supply chain, making sure that suppliers get paid more quickly. It’s like ensuring that all the gears in a big machine work well together, so there are no unexpected stops or breakdowns.
When it comes to reverse factoring, ComparedBusiness is here to help you save time and money. You can easily submit your business requirements through ComparedBusiness in under 2 minutes.
You will get quotes from top Reverse Factoring companies delivered to your email. You can then compare and choose the most suitable option per your business needs.
Yes, reverse factoring can be particularly beneficial for small businesses. It allows small business suppliers to receive payments more quickly without having to wait for too long. Suppliers can use this money to get more orders without having to disrupt their cash flow.
Reverse factoring typically strengthens the relationship between businesses and suppliers. The businesses make an effort to facilitate faster payments to suppliers. It shows their commitment to their suppliers’ financial well-being which can lead to more favourable terms and a more reliable supply chain.
