Reverse Factoring | Complete Guide & Alternatives

Cash flow is one of the most important considerations for links in a supply chain. With payment terms potentially causing difficulties for businesses looking to run smoothly, solutions that can speed up payments for suppliers without impacting buyer cash flow are essential.

Clifton Private Finance are experts, perfectly positioned to help with supply chain finances - read on for a full understanding of reverse factoring and how it can lift stress off your business’s cash flow. 

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How Reverse Factoring Works

Reverse factoring is unusual in that it is a buyer-initiated financing solution, helping their suppliers get paid without impacting the payment terms that they enjoy for their own cash flow purposes.

The stages of reverse factoring occur as follows:

• Invoice is issued by supplier - Having provided goods or services, the supplier invoices the buyer as usual.
  
  
• Invoice is passed to the finance provider - Rather than pay the invoice outright, or schedule it for payment on its due date, the buyer sends the invoice to the finance provider with whom they have a reverse factoring credit facility.
  
  
• Finance provider offers early payment to supplier - Payment is not automatic, rather the offer to make the payment is made. This will be for the invoice total minus the discount that represents the provider’s fee. Unlike funding that is sourced by the supplier to cover an early invoice payment (an invoice finance solution) the discount is calculated based on the buyer’s creditworthiness.
  
  
• Supplier accepts terms - To get the invoice paid immediately, the supplier simply accepts the offer.
  
  
• Finance provider pays invoice - The invoice is paid as agreed.
  
  
• Buyer repays finance provider - The buyer pays the full amount to their finance provider on the original due date, in accordance with the payment terms of the invoice. 

The Benefits of Reverse Factoring

One of the key considerations of reverse factoring is that it benefits everyone involved:

Supplier Benefits

• Immediate Payment - The rapid payment provides the supplier with the business cash flow they need to meet their operational expenses and continue to grow their business without being held back by payment terms.
• Lower Costs - Discounting fees are calculated based on the buyer’s creditworthiness, rather than the supplier’s own credit history. For businesses smaller than their customers, this can have a substantial impact on the rates offered when compared to more traditional loans or forms of financing.
  
  
• Minimal Administration - As the bulk of the administration is undertaken by the buyer, there is very little cost to the supplier, no application process, and no pressure placed on the business’s credit score.

Buyer Benefits

• Improved Relationships - From a basic standpoint, it can be seen that the buyer is doing their suppliers a favour, as there is no pressure on them to offer this service. This puts the buyer in a far stronger negotiating position with their suppliers.
  
  
• Extended Payment Terms - As a longer payment term has little impact to the supplier, they are more likely to offer extended terms, such as 90- or 120-days net. This improves the buyer’s cash flow without negatively affecting their suppliers.
  
  
• Low Costs - While there are ongoing administrative fees for reverse factoring revolving credit facilities, the bulk of the fees are covered through the supplier’s discount to the finance provider.
  
  
• Ongoing Relationship with Finance Provider - Building a long-term relationship with their finance provider improves the buyer’s overall standing and widens the scope for future funding requirements.
  
  
• Stable Supply Chain - Through reverse factoring, both the buyer and their suppliers are more stable, improving their positions as links in the overall supply chain.

Finance Provider Benefits

• Low Risk Profit - Reverse factoring is seen as a low-risk funding plan, leveraged with strong credit ratings from buyers. Both ongoing administrative fees and supplier discounts provide comfortable profits.
  
  
• Improved Relationships with Multiple Businesses - Not only is the relationship solidified with the buyer, but new relationships are built and nurtured with all the supplier companies, providing the finance provider with strongly qualified leads for future business. 

Who Uses Reverse Factoring?

Reverse factoring relies on the strength of the buyer's creditworthiness and is, therefore, most typically used where there is a significant difference in size between the buyer and their suppliers.

Their suppliers are typically significantly smaller: SMEs who are in the position of relying on the relationship as part of their own growth strategies.

For these smaller companies, discounting the invoices to smooth cash flow and avoid the struggle of long payment terms is an acceptable balance, especially considering the preferential rates provided due to the power leveraged by the buyer. 

An Example of Reverse Factoring in Action

The Problem

A multinational electronics manufacturer, SuperTech123 PLC, relies on a large number of small component suppliers.

Given the size of their orders and the value of their business, SuperTech123 are able to demand 120-day payment terms.

Possible Solutions

SuperTech123 can see several potential solutions:

• To use alternative suppliers - While this is a possibility, it has a number of problems of its own, not least having to test and implement standards with a host of new unknown manufacturers. It is potentially both risky and costly and there is no guarantee the problem will not surface again later.
  
  
• To accept shorter payment terms - This option could be done, but it would put significant pressure on SuperTech123’s own cash flow and stifle many expansion plans. It is not a proposal that is likely to be seen favourably by board members or shareholders.
  
  
• To implement dynamic discounting - This would solve the problem for the suppliers and put less pressure on SuperTech123’s cash flow than shorter payment terms, but ties up money earmarked for expansion in a similar way.
  
  
• To offer reverse factoring - A reverse factoring programme would provide suppliers with the cash flow support they need with a relatively minor impact to SuperTech123’s cash flow.

Reverse Factoring in Practice

SuperTech123 work with a trusted finance provider to open a significant revolving line of credit for reverse factoring and offer the option to their suppliers.

Somewhat unsurprisingly, over 85% of their smaller suppliers choose to take advantage of the offer, with feedback showing that the discounts are seen to be a low-impact and acceptable cost for the significantly improved cash flow.

The supply chain problems are resolved within the first few months of the new reverse factoring scheme going online.

SuperTech123 continue to pay their invoices on 120-day terms, only now a substantial number of supplier invoices are paid via the reverse factoring provider.

The Results

• SuperTech123 PLC benefits from improved relationships with suppliers and their finance provider.
• Supply issues are minimised.
• Suppliers enjoy stabilised cash flow and are able to expand to improve their offerings. 

Alternatives to Reverse Factoring

Reverse factoring is an extremely effective method of improving cash flow for suppliers without direct impact on cash flow, however it is only one of several trade finance and supply chain finance solutions for businesses.

Significant alternatives include:

Invoice Finance

Initiated by the supplier rather than the buyer, invoice finance products offer a way for B2B businesses to leverage their unpaid invoices for immediate capital and cash flow relief.

With two main products, invoice factoring and invoice discounting, invoice finance provides flexible and customisable solutions to cash flow problems.

Learn more about how invoice finance can help your business in our knowledge base articles.

Dynamic Discounting

From a supplier perspective, dynamic discounting can offer very similar terms to reverse factoring, with invoices paid early if a discount is applied.

However, from a buyer point of view, dynamic discounting has a real impact to cash flow and payment terms, with surplus capital utilised to incentivise discounts.

With dynamic discounting, the buyer benefits directly from the discounts, rather than passing that potential profit to a third-party finance provider in exchange for improved cash flow.

Comparing Three Forms of Supplier/Buyer Finance

Supplier / Buyer Finance Comparison

Reverse Factoring with Clifton Private Finance

For businesses with the strong creditworthiness needed to support the supply chain, reverse factoring represents a hugely powerful finance tool that provides benefits to all parties.

Using it is a strategy that leads to stronger relationships and more stable supplier/buyer relationships to the advantage of everyone involved.

To find out more about how reverse factoring can work to your advantage while helping the smaller suppliers that provide your business with essential goods and services, speak to one of Clifton Private Finance’s corporate finance experts today.

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