Reverse factoring, also known as supply chain factoring, is a financial tool that optimizes cash flow and reduces the cash flow impact of longer payment terms on suppliers. It enables the ordering party to pay their suppliers quickly and more efficiently with no additional cost to the ordering party.
How Does Reverse Factoring Work?
There are three parties involved in reverse factoring: The ordering party, the supplier, and the funder. It is a pretty simple system and the steps are as follows: A business orders goods from a supplier. The goods are sent and an invoice is sent to the ordering party. The ordering party approves the invoice and sends it to the reverse factoring provider. A percentage (typically 80%) of the invoice value is advanced to the supplier. Finally, the ordering party pays the invoice value to the funder when it becomes due, and the funder sends the remaining 20% of the invoice value to the supplier minus the funder's fee.
What are the Benefits of Reverse Factoring?
- Reverse factoring links parties in a transaction for lower costs and improved efficiency
- Beneficial for both the ordering party and the supplier, improving the working relationships
- Since suppliers are being paid as soon as possible, the ordering party will no longer have to deal with requests from suppliers regarding early payment or renegotiating terms
- Lower interest rates than are typically available to the supplier since it is based on the credit standing of the ordering company
An Example of Reverse Factoring
Company X buys goods from supplier Y. Y ships the goods and sends an invoice to X. X approves that invoice for payment on the pre-negotiated Net 30 payment terms. All business-as-usual so far, right? Now, if supplier Y would like payment before the Net 30 payment terms, they can request immediate payment (at a discount) for the invoice that company X already approved. The financial institution that company X has engaged as a reverse factor we will remit 80% of the invoiced amount to supplier Y. Once company X pays us the invoice total after the 30-day net terms are over, we pay the remaining 20% of the invoice total to supplier Y minus our discount.
Reverse factoring can be an effective way of improving working capital, creating long-term relationships between companies and their suppliers, and efficiently settling invoices. This financial tool benefits both buyers and suppliers and allows businesses to access the capital they need when they need it.