What is factoring?
Factoring, or accounts receivable factoring, is a type of transaction in which a business/seller sells its accounts receivable to a third-party factoring company at a discount. This process allows the business to immediately convert their receivables into cash, improving liquidity and enabling them to meet short-term financial obligations without waiting for customer/buyer payments.
Unlike traditional loans, this process doesn’t involve creating debt for the company. Instead, it’s a form of asset-based financing, where the company’s receivables serve as the asset. The factor advances a significant percentage of the invoice value (typically 70% to 85%) and then takes the responsibility of collecting payments from the customer.
It’s especially useful for companies with long payment cycles or those experiencing rapid growth. In these cases, waiting for customer payments could hinder their operations; thus factoring is employed. It not only improves cash flow but also reduces the risk associated with non-payment, as factors often assume the credit risk of the receivables.
Traditional factoring is also known as debt factoring
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What is reverse factoring?
Reverse factoring is a financial arrangement where a buyer initiates the process to help their suppliers get paid faster by a third-party financial organisation. In this setup, the buyer (who is generally a large company), arranges for a bank or factoring company to pay their suppliers promptly on their behalf.
The financial institution then collects the payment from the buyer on the agreed-upon due date. Because the buyer typically has a strong credit profile, the financial institution offers this service at lower financing costs than the supplier could obtain on their own.
How do reverse factoring and factoring work?
Let us review the process with which both reverse factoring and factoring work. This information will help you choose the most suitable option for your position as a supplier or a business.
Traditional Factoring
1- You raise an invoice: The business raises an invoice with its customers, completes it and delivers the products. Afterwards, instead of waiting for the invoices to clear, the business can sell them to a finance company.
2- You submit an invoice to a factoring company: Select high-value invoices and submit them to the factoring company for review. They conduct a credibility check and evaluate the creditworthiness of the invoices.
3- You receive an advance payment: The factoring company decides on an advance payment (usually 70%-90% of the invoice value), and the business receives it upfront.
4- Factoring company collects the payment: The payment collection process is handed over to the factoring company until all the invoices are cleared.
5- You receive the remaining balance: The remaining balance (10%-30%) of the invoice value is transferred to the business after deducting the factoring fee (3%-5% of the total value).
Reverse Factoring
1- You deliver goods or services: In the case of reverse factoring, we assume that you (the business in question) are a supplier in a supply chain of B2B businesses.
2- The buyer approves the invoice: After completing the invoice, the buyer approves it and confirms that they have received the goods and services. To help clear the invoice earlier, the other business initiates the reverse factoring process with a provider. Your business is not directly involved in the process.
3- The finance provider offers early payment: As a result of the agreement, the finance provider timely clears the invoice so you can avoid any cash flow problems and continue to promptly supply products and services.
5- The buyer repays the finance provider: As for the reverse factoring fee, it is paid by the other business, not you. The buyer would have a flexible monthly payment schedule with the finance provider. As a supplier, your part is only until you receive your invoice in full.
Reverse factoring vs factoring: the difference
1. Initiation of the process:
In factoring, the supplier or the seller initiates the process. They sell their receivables to a financial institution. In reverse factoring, the buyer initiates the process where it arranges for a factoring company/bank to pay their suppliers quickly.
2. Party that gets benefitted:
Although both pirates get benefitted because of these transactions but in factoring, it’s the supplier who gets the most benefit because its receivables are coveted into immediate cash. Reverse factoring focuses on the buyer’s desire to support their suppliers. It benefits the supplier by providing faster payments but is driven by the buyer’s need to maintain a healthy supply chain.
3. Credit risk:
In factoring, the factoring company assesses the creditworthiness of the supplier’s customers because the repayment risk lies with those customers. In reverse factoring, however, the financial institution assesses the credit risk of the buyer, not the supplier, since the buyer is responsible for repayment.
4. Cost of the process:
The cost is typically higher in factoring because the supplier’s credit risk along with their customers, is often greater than the buyer’s. It’s usually between 1% to 5% of the invoice value.
Reverse factoring offers lower financing costs because it relies on the buyer’s strong credit profile. We discussed earlier that it’s often initiated by a buyer who is a large and creditworthy company.
Get a better idea about invoice factoring costs for 2026 with our detailed guide. Read here: Invoice factoring rates
Reverse factoring vs factoring: Summary
The differences are summarised in the table below.
| Criteria | Factoring | Reverse factoring |
|---|---|---|
|
Initiation of the process |
The supplier initiates the process by selling receivables to a financial institution. |
The buyer initiates the process by arranging for the factoring company to pay their suppliers quickly. |
|
Party that benefits most |
Supplier benefits most by converting receivables into immediate cash for better liquidity. |
Buyer benefits by maintaining a healthy supply chain, while suppliers benefit from faster payments. |
|
Credit risk |
Credit risk is assessed on the supplier’s customers, as they are responsible for repayment.
|
Credit risk is assessed on the buyer, as they are responsible for repayment to the financial institution. |
|
Cost of the process |
Typically higher (1-5% of invoice value) due to the higher credit risk associated with suppliers and their customers.
|
Generally lower, as it relies on the buyer’s strong credit profile, often a large and creditworthy company. |
Benefits of reverse factoring for businesses
Reverse factoring comes with various advantages just like factoring.
- Improved cash flow for suppliers:
In traditional invoicing, suppliers often wait 60-90 days to receive payment from buyers. Reverse factoring addresses this issue by allowing suppliers to receive payment as soon as they issue an invoice.
This immediate cash helps them cover their running expenses and invest in new opportunities without needing to opt for high-interest bank loans.
- Relationships with buyers improve:
The prompt payment by reverse factoring can significantly improve the relationship between buyers and suppliers. Suppliers value the reliability of getting paid early, which can translate into more favourable terms for the buyer such as discounts.
This stronger relationship fosters greater collaboration and trust, which is crucial in industries where supply chain reliability is pivotal.
- Lower financing costs:
Financing costs are typically lower in reverse factoring because the financing is based on the buyer’s creditworthiness rather than the supplier’s. Buyers can secure better interest rates compared to what suppliers might obtain on their own.
This reduction in cost is passed on to the suppliers, making reverse factoring a more affordable financing option. This helps suppliers improve their profit margins as well.
- Off-balance-sheet financing:
Reverse factoring can be structured as off-balance-sheet financing which means it does not appear as debt on the buyer’s balance sheet. This allows them to improve their financial ratios such as debt-to-equity, without the need to reduce their actual debt levels.
As a result, it makes the company appear more financially stable and attractive to lenders, potentially lowering the cost of capital further. For suppliers, this arrangement offers the benefit of early payment without debt, preserving their borrowing capacity for other needs.
Also learn about the advantages and disadvantages of factoring
When to go for Reverse Factoring vs Non-Reverse Factoring
Traditional factoring is for SMEs that need to improve cash flow without waiting for 30-90 days for payment. It is for businesses that have a constant inflow of invoices from customers with long payment cycles. Since in traditional factoring, the factor connects with the customers directly, the business needs to be comfortable with this setting. The customer relationship and the business image may take a hit once the customer finds out that the business has been financing the invoices. It is suitable for businesses that want to outsource the credit handling entirely.
Reverse factoring is typically suited to businesses that have large and creditworthy buyers who want to support the supplier in order to strengthen their supply chain. If the buyer are enterprise-level businesses, they prefer reverse factoring for their suppliers because it improves their supplier-buyer relationship. The businesses that prefer reverse factoring belong to industries like FMCG, retail, construction, automobile, etc., where supply chain reliability is critical.
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FAQs
Reverse factoring can be costly for suppliers, as they might pay fees for early payments. Additionally, it depends heavily on the buyer’s creditworthiness, and if the buyer defaults, it can lead to complications.
No, reverse factoring and confirming are not the same. Reverse factoring involves the buyer initiating early payments to suppliers through a financial institution. Confirming is a broader process where a third party handles the payment of invoices but doesn’t necessarily offer early payment options.
Since it’s the supplier who receives early payment from the bank or factoring company through reverse factoring, it will be him who will pay for the fee.
