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What is reverse factoring?

In a payment landscape with rampant late payments and cash flow problems, getting paid early can be an enormous boon to many businesses. That’s why reverse factoring may be something to consider. Find out everything you need to know about reverse invoice discounting, from the benefits of reverse factoring to the way it works, right here.

Reverse factoring explained

Reverse factoring – also referred to as supplier finance or supply chain finance – is a financing solution aimed at providing buyers and suppliers with the working capital they need to handle day-to-day operations. It can help to mitigate the effects of long payment terms, reduce supply chain risk, and boost your company’s cash flow.

But what is reverse factoring? In a nutshell, reverse factoring refers to an intermediary finance company (usually a bank) committing to paying the buyer’s invoices to the supplier at an accelerated rate, in exchange for money off the total amount owed. Because the supplier can choose which invoices to sell to the intermediary, suppliers have the flexibility to get paid early when they’re in need of working capital. 

Generally, reverse factoring is only available to suppliers that already have an established, long-term relationship with a buyer. Generally, it’s initiated by the buyer to improve the supplier’s cash flow situation, thereby shoring up their supply chain.

How does reverse factoring work?

So, how does reverse factoring work? It’s relatively simple. It involves three different parties: the buyer, the supplier, and the intermediary financial company. Here’s a step by step guide:

  1. First, the invoice is sent from the supplier to the buyer for services/goods rendered.

  2. Then, the buyer will approve the invoice and upload it to a factoring service (usually, these integrate with standard accounting software tools).

  3. The supplier can now access the invoice at any time. If the supplier does nothing, the invoice will be paid as normal. However, if the supplier chooses to take advantage of reverse factoring, the receivables will be sold to an intermediary in exchange for early payment.

What are the benefits of reverse factoring?

Reverse invoice discounting has a number of benefits for both buyers and suppliers. Here are some of the advantages of this type of financing solution for the buying side:

  • Reverse factoring enables the buyer to foster closer links to suppliers, as they’ll enjoy the benefits of an accelerated cash flow from faster payment.

  • Buyers won’t need to worry about dealing with early payment requests from suppliers, as the invoice is already being paid as quickly as possible.

  • Furthermore, reverse factoring provides a strategic, non-debt resource that you can use to fund strategic growth initiatives.

Reverse factoring is also beneficial for suppliers. Here are some of the best reasons why suppliers should look closely at the potential advantages of reverse invoice discounting:

  • In exchange for the fee paid to the finance company, the supplier will have their invoices paid sooner than would otherwise be possible, and in a more predictable fashion.

  • Generally speaking, the interest rates charged by the finance company are low, as they’re calculated based on the credit score of the buyer, not the supplier.

  • Reverse factoring may help suppliers to weather turbulent economic conditions, as it reduces the vulnerability associated with waiting around for big clients to pay their invoices.  

In short, reverse factoring gives suppliers access to working capital when they need it, while buyers benefit from a more financially stable supply chain that’s less likely to provide substandard products/services or be late with deliveries.

What’s the difference between reverse factoring and invoice finance?

The key distinction between invoice financing and reverse factoring is the fact that it involves three parties: the supplier, the buyer, and the lender/bank that’s settling the outstanding invoice. Furthermore, with traditional forms of invoice financing, the supplier requests finance. However, with reverse factoring, it’s the buyer who initiates the financing option.

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GoCardless (company registration number 07495895) is authorised by the Financial Conduct Authority under the Payment Services Regulations 2017, registration number 597190, for the provision of payment services. GoCardless SAS (23-25 Avenue Mac-Mahon, Paris, 75017, France), an affiliate of GoCardless Ltd (company registration number 834 422 180, R.C.S. PARIS), is authorised by the ACPR (French Prudential Supervision and Resolution Authority), Bank Code (CIB) 17118, for the provision of payment services.