2 min read
There’s a significant amount of risk inherent within the global supply chain. Whether you’re a buyer looking to ensure timely deliveries from your suppliers or a supplier who needs quicker access to capital, reverse factoring can help to reduce supply chain risk and optimize cash flow. Want to know more? Take a look at our reverse factoring definition, right here.
Reverse factoring definition
Reverse factoring, also referred to as supply chain finance, is a buyer-led financing option where the supplier’s invoice is financed by a bank or financial institution at a discounted rate. Because the invoice has been sold, the supplier receives an immediate cash injection and the buyer gets a little more time to pay the invoice. It’s essentially a three-way financing solution involving the buyer, the supplier, and the financial institution.
How does reverse factoring work?
The reverse factoring process is relatively simple, although it’s important to remember that it generally takes place using a supply chain finance reverse factoring program, so you’ll need access to one of those if you don’t already. Let’s explore a reverse factoring example to see how the process works:
Firstly, Company A (the supplier) sends their invoice to Company B (the buyer).
Then, Company B approves the invoice and uploads it to a supply chain finance program.
At this point, it’s up to Company A as to whether to proceed with the reverse factoring process. If they choose to move forward, the invoice will be sent to Company C (the financial institution) and Company A will receive their payment immediately.
Then, when the invoice matures, Company B will pay the invoice.
The benefits of reverse factoring
There are a wide range of benefits associated with reverse factoring for buyers and suppliers. Here’s why buyers may be interested in reverse factoring:
Longer payment terms – An important benefit for buyers is the ability to increase payment terms without the need to negotiate any other elements of the deal, such as price. This enables buyers to improve their liquidity and cash flow.
Secured supply chain – Another significant benefit is the security that reverse factoring provides for buyers. Due to the earlier cash injection, there’s no need to worry about an interrupted supply chain due to poor cash flow on the part of the supplier. This reduces your risk of late deliveries or substandard materials/products.
Closer links to suppliers – Finally, consider the benefit of improved relationships with suppliers. Because they get paid earlier, your suppliers may be more willing to work with you as they know there’s no chance of late payment.
Of course, there are also plenty of benefits for suppliers, such as:
Speed of payment – The main benefit associated with supply chain finance reverse factoring is the increased speed at which the supplier can get paid. For example, you could end up getting paid in 5 days, rather than 50 days. If you’re in a cash flow crunch and need a capital injection, fast, reverse factoring could be a good move.
Diversified sources of capital – It’s also important to note that reverse factoring can provide suppliers with an off-balance sheet means of maintaining their operations, while it’s also a cheap way to fuel growth.
Navigate difficult economic conditions – When you’re dealing with supply chains, anything can go wrong, and frequently does. Since you’re getting paid much sooner than normal, reverse factoring can help your business build up a capital reserve to deal with any potential issues as they arise.
Reverse factoring vs. factoring
Although reverse factoring and invoice factoring might sound similar, they’re two very different things. Put simply, invoice factoring works in the opposite direction to reverse factoring. Whereas in supply chain finance reverse factoring, the buyer initiates the process where a financial institution factors the supplier’s invoice, traditional invoice factoring is initiated by a supplier who requests finance for an outstanding invoice.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.