Reverse Factoring

Reverse Factoring

For buyers and suppliers alike, there are unique pressures that come with maintaining a supply chain. Buyers require goods and equipment but won’t always have the funds readily available. Suppliers, meanwhile, can be waiting to receive payment a month or more after providing what their customers need. To ease the pressure on both parties, reverse factoring can be the solution – a third-party finance option that works for all parts of the supply chain.

It’s for this very reason that, sometimes, you may hear reverse factoring referred to as “supply chain finance” (or something similar). The ultimate aim of this form of commercial finance is to unlock capital that can get caught up at different points of the supply chain.

But what exactly is reverse factoring? Is it the most appropriate choice for your business? And what do you need to consider? After all, it’s a decision that can have positive and negative financial impacts.

What is reverse factoring?

With some factoring solutions, a supplier sells invoices to a finance provider to release the capital tied up in payments still to come. The use of the term “reverse” here highlights how this solution is different to that. Instead, it’s the buyer who unlocks the finance on behalf of the supplier. The aim of this is to give the buyer more time to pay for its purchase.

The supplier can also take the option of receiving payment for its invoices sooner than the date of maturity. Ultimately, it gives both sides of the transaction a chance to access working capital flexibly. In the middle, the finance provider receives the interest for the length of time it gives the buyer to pay the invoice. All in all, the aim is that everyone benefits.  

What can reverse factoring be used for?

As the buyer, you can use reverse factoring for a broad range of business reasons. In fact, you can use it whenever you deal with a supplier of goods or equipment required for your company.

You might need to secure a fresh supply of stock for that popular line that keeps selling out, for example. Or perhaps there’s a new line of products that will complement your existing offer. You may have even grander growth plans. As such, you’re likely to need the right equipment to make those dreams become a reality.

A willing finance provider and suppliers who are happy to enter into such an agreement are then all you need to set up a reverse factoring facility. 

Reverse factoring explained

Is reverse factoring a potential finance option for your business? Let’s consider how the process works. Once you become familiar with it, it’s quite straightforward. Here’s a step-by-step guide:

−      You agree to buy products or equipment from your supplier.

−      Your supplier sends you the invoice (or uploads it to a reverse factoring facility)

−      As the buyer, you approve the invoice – including the total due and payment date.

−      Your supplier can then request early payment of the invoice (for a small fee).

−      You’ll then pay the invoice amount (plus any interest) by the agreed date.

With a reverse factoring facility, the payment period you’re given as a buyer can often be longer than standard trade credit terms. That’s one aspect in particular that can make it appealing to a business looking to buy without needing to have the full amount in place to start with.

Is reverse factoring the same as invoice factoring?

In short, the answer here is no. The major difference is in the name. The ‘reverse’ element is because it’s the buyer – not the supplier – who initiates the agreement. While a supplier has an opportunity to access early payment, it’s the buyer who arranges the facility with a provider.

Invoice (or spot) factoring is where a supplier ‘sells’ some or all of their outstanding invoices to an external provider. Historically, SMEs are hard hit by late payments and invoice factoring is a way to combat this.

By selling their invoices, a supplier gets a cash advance that’s a share of the total value of those invoices – normally 75-85%. So, a supplier won’t always receive the amount owed in full. But it will give them access to critical cash flow tied up in outstanding payments.

With reverse factoring, a supplier gets the full invoice value unless they opt for early payment.

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What to consider with reverse factoring

As with all forms of business finance, there are benefits and risks with reverse factoring. Being fully aware of the arguments for and against is the only sure-fire way to know whether it could be the right option for your business.

Benefits of reverse factoring

  • The main selling point for buyers and suppliers is that reverse factoring can hugely improve cash flow. Buyers don’t need to have the full order value in the bank to get what they need. Suppliers, meanwhile, can access early payments if needed.
  • The process is designed to work for both sides of a transaction. As such, it’s a good method for keeping the supply chain moving without avoidable disruptions.
  • Reverse factoring can help buyers and suppliers with their accounting. The dates on which money will leave and enter the respective accounts are all clearly defined.
  • For buyers, reverse factoring can make you seem more attractive to suppliers. And that could mean better terms. For suppliers, the cost of funding is lower because the onus is on the buyer’s credit rating – not yours.

Pitfalls of reverse factoring

−      If you agree to a reverse factoring facility, it can tie you into an arrangement with little flexibility. For suppliers, this can mean operating on terms that suit your buyer(s). You may, however, prefer to do things your way.

−      There’s always a risk of damaging your credit rating if you, as a buyer, fail to pay what you owe by the date specified. The responsibility for reverse factoring always falls on a buyer – not a supplier. You may also be rejected if your credit score isn’t good enough.

Am I eligible for reverse factoring?

This is only a question to ask yourself if you’re in the ‘buyer’ position. If so, there are two key points to consider when it comes to your eligibility:

−      Do you have a healthy business credit rating? This is likely to be the biggest obstacle when it comes to getting a reverse factoring facility. If not, you could find that you’ll struggle to find a willing finance provider.

−      Is your supplier prepared to agree to the arrangement? If not, you’ll have to think of alternative solutions to get the capital you need.

Should I apply for reverse factoring?

Any credit or finance decision should be based on your individual needs as a business. Are you in need of new equipment to expand your operations? Would you like to add new stock to your offering? When the biggest barrier is your available capital, reverse factoring could help.

It’s also a decision that you must take in full possession of the facts. It isn’t the right option for all businesses. And it might not even be an option available to you. So, make sure you explore all the solutions that could benefit your business and choose one that fits best with your aims.

Reverse factoring won’t work for me – what should I do?

Have you examined your options and decided that reverse factoring isn’t a path for your business to choose? First and foremost, the important thing is not to stress. There’s a wealth of funding solutions at your disposal. Our role is to connect you with one that works best for you.

We can provide SMEs with funding between £3,000 and £50 million across a range of seven business finance products. No matter your ambitions, contact us now for a no-obligation consultation and quote. Together, let’s ensure your business is best placed to realise its full potential.

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