Everything Businesses Need to Know About Reverse Factoring
In this guide, our experts will give you everything you need to know about reverse factoring.
This is a collaborative financing method available to businesses that has a number of benefits. It can improve cash flow, assist with budgets, and most importantly, make growth plans a reality.
Unlike other invoice finance products, this solution provides extra support for suppliers and businesses directly.
It does this by utilising a 3rd party finance provider that pays the producer on behalf of the buyer.
This means a business can get on with the day-to-day running of its operations without worrying about its cash flow situation and the supplier receives a smoother experience – accelerating receivables with lower-cost financing.
What does reverse factoring mean?
In finance, factoring is usually when an external party buys or manages a debt or invoice from a business or company.
Most markets consider factoring to be a form of invoice discounting, as the two share a number of similarities, but factoring specifically involves transferring ownership of accounts to another party.
This party is then responsible for chasing up the debt.
But how does this relate to reverse factoring?
Well, reverse factoring – also known as supply chain financing – is when a finance company, such as a lender or bank, places itself between a business and its suppliers. Instead of chasing up outstanding invoices from customers, the lender will pay the supplier directly.
In these instances, the invoice is paid at an accelerated rate in exchange for a discount – making it a less costly way to boost accounts receivable receipts for suppliers.
This accelerated cash flow takes the strain off business’ when it comes to maintaining crucial relationships with suppliers.
It can also streamline communications between the two as the lender will pay the invoice as early as possible, so no one is chasing up outstanding payments.
So, how does the Reverse Factoring Process work?
If you’re thinking about exploring a reverse factoring platform, it’s important to get a full understanding of how it works.
A reverse factoring plan is often established by a company who makes sure their supplier is happy with this method of payment. Then it’s business as usual, with a company receiving their order from their chosen supplier and approving the invoice.
The supplier will then ‘sell’ the unpaid invoice to a 3rd party finance provider at a discounted rate, in exchange for a speedy payment.
This means that the lender can advance up to 100% of the full value of the invoice to the supplier as soon as it is raised.
But what about the business?
Well, they will have already negotiated the terms of the agreement with the lender, often to increase the length of time needed to pay the full invoice.
They then pay the financial provider the value of the invoice, plus interest – thus completing the ‘supply chain’.
With this solution, suppliers get super-quick payments for their services without chasing invoices and businesses don’t have to worry about footing large bills while keeping operations moving.
What is the main difference between traditional factoring and reverse factoring?
As we touched on earlier, although supply chain finance sits within invoice finance and can look similar, the two have some big differences.
Invoice finance methods
In the majority of invoice finance methods, often the whole value of the invoice is free for factoring. This is in contrast to the discounted amount that is on offer through a normal factoring deal.
Invoice financing also requires a lender to provide up to 90% of an unpaid invoice to the supplier of goods that have been delivered to a business. Whoever took out this loan is then responsible for recouping the value of their invoice to pay back the finance provider, as well as any of the chasing and admin that might involve.
However, as it is the business that sets up the arrangement and is solely responsible for paying it back, customers don’t need to be aware of their involvement – unless a business decides to get the assistance of a credit controller.
On the other hand, reverse factoring involves the business paying up to 100% of an unpaid invoice directly to the supplier. This is because the business is the one that sets up the arrangement with the supplier’s say-so – and also agrees to pay back the sum of the invoice plus interest.
What are the benefits of reverse factoring?
Reverse factoring closes that gap between payments and invoices, meaning that businesses who offer it to suppliers may be able to negotiate better terms. This includes cheaper and longer payment schedules as well as the improvement of working capital. Businesses can take full advantage of their discounted cash flow while enjoying plenty of time to pay the outstanding invoice.
As in any industry, a supplier knowing when they will be paid greatly improves their ability to plan for the future. For businesses, it becomes easier to budget and schedule payments alongside day-to-day operation costs.
Reverse-factoring improves both suppliers and business’ balance sheets as it is an off-balance sheet finance option. By enabling faster and cheaper access to future financing, suppliers can improve their cash flow and working capital.
Which businesses can utilise this solution?
Reverse factoring is typically only available to larger businesses with established relationships with suppliers, however, it can be used across a number of sectors.
For smaller businesses, reverse factoring is rarely used because it takes time to set up a new supplier in a company’s system – which can make the process much longer overall.
To get a supplier to agree to take part in reverse factoring often relies on a good existing working relationship, which, combined with the time it can take to source a 3rd party supplier can cause issues for smaller companies.
For finance brokers who are searching for financial support for their clients, but are unsure of which option will be most effective, we’d be more than happy to help.
At Time Finance, we offer complete financial solutions to small and medium-sized enterprises – with years of expertise under our belts.
Whatever you need, we’re on hand to assist. We can design an agreement to your exact specifications using a full suite of financial goods, or simply tailor an existing solution to move with your plans as they grow.