What Is Reverse Factoring? Reverse factoring, also known as supply chain finance, is a financial arrangement where a buyer initiates a program with a financial institution to pay its suppliers early, while extending its own payment terms. The financial institution pays the supplier directly, often at a discounted rate, and the buyer then repays the financial institution on the original invoice due date. This benefits both the buyer, who gains extended payment terms and potential cost savings, and the supplier, who receives early payment and potentially lower financing costs.
How it works:
The buyer (often a large company with strong credit) sets up a reverse factoring program with a financial institution (like a bank or factoring company).
The buyer repays the financial institution on the original invoice due date, often at a later date than they would have paid the supplier directly.
Benefits for the Buyer:
The buyer gets more time to pay their suppliers, improving their working capital and cash flow.
Reverse factoring can offer lower financing costs compared to other options.
By offering early payment to suppliers, the buyer can foster stronger relationships and potentially negotiate better terms.
Benefits for the Supplier:
Suppliers receive payment sooner than the original invoice terms, improving their cash flow and potentially reducing financing costs.
Since the financing is based on the buyer’s creditworthiness, suppliers can often access lower interest rates than with traditional financing.
Consistent and predictable cash flow from early payments can improve the supplier’s financial health.
Example:
Imagine Walmart (the buyer) establishes a reverse factoring program with a bank. A supplier sends an invoice to Walmart for goods sold. Instead of waiting 60 days to pay the supplier, the bank pays the supplier immediately. Walmart then pays the bank at the end of the 60-day period. This allows Walmart to hold onto its cash longer, while the supplier gets paid sooner.
Benefits for the Factor:
The factor in a reverse factoring arrangement obviously benefits due to the fact that it will source multiple new clients with a single sales presentation. Additionally, the need for invoice verification will become almost non-existent since the customer (ordering party) will submit all approved invoices for “quick pay” directly to the factor.