Imagine ordering goods from a supplier without getting constant payment reminders or paying higher interest rates. It’s possible with a reverse factoring financing agreement.
Reverse factoring is an effective buying strategy that allows buyers to negotiate longer payment terms at more favorable rates based on the buyer’s credit.
Reverse factoring (also known as “supply chain finance” or “supplier finance”) allows buyers to negotiate longer payment terms for supplier invoices by offering the supplier immediate cash payments on approved invoices through a third-party funder, lender, or factoring company.
For suppliers, this financing method means that they receive their payments on their invoices right away (or within a few business days) from the third-party company. The buyer then pays the finance provider or factoring company when the invoice or open receivable is due, based on the net terms agreed upon.
What most companies don‘t realize is that there are modern alternatives to traditional factoring and reverse factoring. Alternative solutions to factoring, like Resolve, are safer and better for a company‘s reputation than factoring.
With Resolve, buyers and suppliers access a better way to manage their net terms without going through the traditional factoring system.
Take Trenchless Supply‘s founder and CEO, John Sanzone, who knew he needed an alternative financing solution that was better for his company‘s reputation than factoring. He wanted a solution where invoices and collections were still handled by a third party, but still allowed him to maintain complete ownership over customer relationships and solve his AR challenges).
Benjamin Klingner, owner of GB Fabrication, also needed a factoring alternative. Having researched traditional invoice factoring solutions in the past, he was concerned with handing over accounts receivables to a third-party. His team was also worried that working with a third party for invoice financing could give off the signal that the company was experiencing financial trouble, which they weren’t.
Trenchless Supply and GB Fabrication both discovered an alternative to factoring: Resolve (which Benjamin even called better than popular payment solution Bill.com). Resolve proved to be very different from traditional factoring while offering benefits to both the buyer and supplier.
For buyers, Resolve offers net terms and credit limits approvals within 24 hours. The buyers receive the benefit of longer payment terms (30, 60, or 90 days), visibility into their credit lines, and versatile B2B payment processing options.
For suppliers, they stay in full control of their accounts receivables and customer relationships with Resolve. Using Resolve’s simple and intuitive portal, they select which invoices to offer net terms on and have the option to receive an advance payment of up to 90% on these invoices. Resolve‘s automated platform also takes care of all invoicing and collections for the seller, acting like an outsourced AR team.
Resolve offers a stress-free B2B accounts receivable solution that provides longer payment terms, increased working capital, and better cash flow management for both buyers and suppliers.
Want to learn more? Here are the 8 reasons Resolve is better than factoring.
Reverse factoring derives its name from traditional factoring. In traditional factoring, the seller of the goods or services asks an invoice factoring company for finance. However, with reverse factoring, this process is initiated by the buyer, hence the term reverse factoring.
Through the reverse factoring process, the lender will consider the buyer’s creditworthiness rather than the supplier’s credit rating. This often provides buyers with more favorable interest rates and gives the seller immediate cash for the invoice without the need to wait for payment over their typical Net 30 or 60+ day payment period.
Reverse factoring often carries lower costs than if the supplier would seek funding on their own. This works because banks are more likely to extend favorable receivables financing to large companies, rather than enterprise or mid-level companies. To lenders, more established companies represent low credit risk, hence the predictably favorable terms.
Here’s the simplified, six-step process for a reverse factoring program:
- The buyer purchases services or goods from a supplier on credit.
- The supplier will start the reverse factoring process by uploading the invoice to the factoring platform, clearly stating the amount and payment dates.
- The buyer will acknowledge receiving the goods and approve the invoice.
- The supplier will request immediate payment from the factoring company through the platform.
- The reverse factoring company will send the supplier early payment for the full invoice amount, less any administration and processing fees.
- On the invoice maturity date, the buyer will pay the factoring company directly. Do keep in mind the accounting treatment of reverse factoring. You should classify the program not as a bank loan but rather as an off-balance sheet solution.
Reverse factoring arrangements reduce the time it takes for a supplier to receive accounts receivable payments, thereby improving cash flow.
Remember, reverse factoring is not the only solution to solving accounts receivable and cash flow challenges. Alternative solutions like Resolve offers a complete B2B credit management and net terms solution that takes care of everything in a win-win arrangement for everybody involved.
Historically, banks have provided the financing solution for reverse factoring, but more modern solutions from non-financial institutions and third party solutions also offer reverse factoring financing methods.
Larger corporations and established businesses generally have more success engaging in reverse factoring agreements with banks as they hold a lower perceived financial risk to the lender. On occasion, banks will also extend this program to smaller companies, but smaller companies often have better success (and rates) working with other third-party reverse factoring companies that specialize in their business model and size.
Many industries and businesses can benefit from reverse factoring agreements with their suppliers. However, most reverse factoring firms tend to favor large middle-market businesses, such as those found in the following industries:
- Gas and oil
- Service providers
Reverse factoring is a mutually beneficial financial arrangement for the buyer and seller. Here’s a sampling of the advantages of reverse factoring:
- Reduces supply chain disruption: Reverse factoring eliminates the possibility of supply chain disruptions because the supplier receives their payment faster and can prepare the order immediately.
- Creates more favorable payment terms: Buyers are purchasing goods on what equates to a cash deal for the supplier so they can negotiate favorable payment terms with the supplier which gives them more negotiation power.
- Improves working capital: By increasing your DPO (days payable outstanding), you can increase your working capital.
- Reduces early payments requests: Buyers can take the time to collect the cash for the invoice, without worrying about pressure for quick or early payments from the supplier.
- Strengthens supplier relationships: Buyers can use this method to strengthen the working relationship with their supplier by providing a beneficial reverse factoring payment agreement. This also makes it more attractive for other suppliers to work with buyers who engage in reverse factoring because of the fast payments they will receive.
- Saves buyer fees: In these agreements, the supplier usually pays all interest rates and processing fees to the factoring company, even though the buyer requested the financing.
- Improves cash forecasting: Reverse factoring promises immediate payments to suppliers, making it easier to predict business cash flow to optimize business operations and plan for the future accordingly.
- Reduces interest fees: The funder will consider the credit history of the buyer, and can often extend a more favorable interest rate and lower fees.
- Improves working capital and cash flow: With this financing method, suppliers receive payments as soon as the invoice is issued so they can improve cash flow, working capital, and reduce DSO (days sales outstanding). In turn, suppliers can thereby pay their suppliers much faster too. Learn how Resolve helped Archipelago increase working capital and triple their business revenue.
- Guarantees payment receipt: Suppliers don’t need to worry about outstanding or overdue payments from disorganized or late-pay customers. The reputable, third-party funder will advance the cash payment immediately upon receipt of the invoice, and will then be responsible for collecting the payment from the customers on the supplier’s behalf.
- Creates positive financial statements: Reverse factoring is an off-balance sheet mechanism because it creates better trade payables, capital turnover, and turnover payable ratios. This makes the balance sheet look more positive and keeps shareholders and investors happy.
- Optimizes administrative and back-office processes: Reverse factoring is a great addition to business automation processes. Without it, companies would need to invest significant time and resources into collections, processing payments, and managing cash flow shortfalls. Reverse factoring optimizes business processes so teams can focus on other, more value-added tasks.
Reverse factoring can also damage the buyer‘s supplier relationships.
- If not done through a reputable third-party funder or reverse factoring company, complicated contracts, and ambiguous clauses can cause extra expenses for the supplier or the buyer.
- If the buyer fails to pay on time, the funder may pull the plug on the collateral, disrupting cash flow and liquidity. The arrangement is heavily dependent on the financial sanctity of the buyer.
Dynamic discounting and reverse factoring can appear to be quite similar. With dynamic discounting, the buyer offers to make early payments to the seller in exchange for a discount. The buyer will source the cash, maybe even through a funder, to secure risk-free returns, eliminating chances of supply chain disruptions.
With reverse factoring, a third party is always involved who acts as an intermediary to ensure the supplier is paid immediately and collects the payment from the buyer on the invoice due date. The buyer is not responsible for sourcing their own funding and a traditional invoice “discount” is not extended, although there may be savings to the buyer in the form of the interest rate and terms.
If buyers need a solution to minimize supply chain disruptions and improve cash flow, reverse factoring may be an effective strategy to implement with suppliers.
But don‘t forget that there are now modern alternatives. Factoring is not the only solution. Trusted partners like Resolve help buyers and suppliers streamline the entire net terms management process that creates a win-win solution for all parties with less risk and fees than a traditional factoring solution.
Request a demo today to learn how Resolve provides a seamless net terms solution that has valuable benefits for both buyers and suppliers.