Wouldn’t it be nice to get goods from your supplier and not have to worry about getting constant reminders about payments and without the threat of the seller cutting off supplies for non-payment?
That is precisely what reverse factoring, a form of trade finance, offers. Keep reading to learn more about the peace of mind reverse factoring promises and the improvements in cash flows it guarantees.
Reverse factoring, or supply chain financing, is a supplier finance product that allows an established organization to extend or maintain its longer payment terms by offering early payments on approved supplier’s invoices.
Suppose you are a purchaser and intend to use this reverse factoring. In that case, you will request your financier to make early payments on approved invoices to a supplier, on condition that you will pay the finance provider when the invoices/open receivables are due. The best solution however is not factoring, Resolve is known as ‘modern factoring’ and is safer and better for your reputation than factoring. See, 8 Reasons Resolve is Better Than Factoring.
Reverse factoring derives its name from conventional factoring. Unlike factoring, where the seller asks an invoice factoring company for finance, the purchaser initiates the funding request, hence the term reverse factoring.
Incidentally, the lender will consider the buyer’s creditworthiness rather than the supplier’s credit rating when deciding to extend funding.
Typically, reverse factoring will carry lower costs than if the supplier were to seek funding on their own. That’s because banks generally only extend such terms to large companies, such as an enterprise venture. To lenders, these entities represent low credit risk, hence the predictably favorable terms.
That said, this is how the financing method usually works:
- The buyer purchases services or goods from a supplier on credit
- The supplier will start the reverse factoring process by forwarding 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 payment
- The reverse factoring company will send the supplier the invoice amount payment, less factoring fees
- On the invoice maturity date, the buyer will send payment to the funder
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.
The whole goal of reverse factoring arrangements is to reduce the time between accounts receivable payments, thereby improving cash flow, and that is where the factoring alternative called Resolve shines through. Resolve offers a complete net terms and credit management solution that takes care of everything needed to provide credit terms.
With Resolve, you don’t even need to fill in a form, but they will approve net terms and credit limits within 24 hours. You can choose which invoices you want to offer net terms. They will even take care of the invoicing and collections if needed.
Resolve offers a stress-free accounts receivable solution that promises to place cash in your hands within 24 hours of invoice approval.
Banks usually provide the financing solution, but several platforms from different financial institutions offer reverse factoring arrangements.
Banks typically only provide this financial service to established firms and rarely engage small businesses because of their perceived high risk. However, it is not unheard of for banks to deal with smaller companies.
While it is clear that many industries and types of businesses would greatly benefit from reverse factoring, only a select few qualify for the services, as discussed above.
Most reverse factoring firms tend to favor large middle-market businesses, such as those found in the following industries:
- Gas and oil
- Service providers
Both the buyer and seller will enjoy the advantages of reverse factoring, such as:
- Reduces supply chain disruption: reverse factoring eliminates the possibility of disrupting the supply chain since the supplier will receive their pay immediately so they can source provisions to meet orders.
- Better negotiation position: since you are purchasing goods on what is essentially cash, you can negotiate favorable payment terms with the supplier.
- Improves working capital: this is a nifty way of increasing your working capital as reverse factoring will reduce days payable outstanding (DPO), indicating you can pay your bills on time.
- Reduced early payments requests: the pressure of suppliers’ demands for quick or early payments is off; collect the cash at your own pace.
- Strengthen relationship with a supplier: buyers can strengthen the working relationship with their suppliers by providing the invaluable reverse factoring program. Other suppliers would want to work with you because of the quick payments your business generates.
- The discount fee to suppliers: although you request the financial instrument, the supplier will bear the transaction cost, since the finance company will deduct a nominal interest income per invoice.
- Improved cash forecasting: since reverse factoring promises immediate payments, it is easier to predict cash flows and plan the future accordingly, ensuring the business runs smoothly.
- Reduced discount fee: unlike traditional factoring, the funder will consider the buyer’s credit history, and they are customarily very successful businesses. Therefore, the interest rate is going to be minimal.
- Improves working capital: since you receive payments as soon as you issue the invoice, this improves working capital, reduces the day’s sales outstanding (DSO), and you can pay off your suppliers.
- Reduces friction: you don’t have to worry about non-payment or fraudulent customers because a reputable third-party financial institution is involved, invoices are agreed on beforehand, and payments are issued almost immediately.
- Improves cash flow: the lender will typically release payments within 24 hours of the buyer’s invoice approval, massively improving cash flows.
- It makes the financial statements look presentable: since reverse factoring is an off-balance sheet mechanism, it creates better ratios like trade payable turnover and capital turnover that make the balance sheet look good, keeping the shareholders and investors happy.
- Administrative back-office optimization: without a reverse factoring program, you would need a team of professionals to handle outstanding invoices, payments, and the accompanying cash flow shortfalls.
- Done poorly, it can be costly for the supplier as the complicated contracts may contain ambiguous clauses.
- The arrangement is heavily dependent on the financial sanctity of the buyer. If they fail to make the payments on time as stipulated in the invoice terms, the funder may pull the plug on the collateral, disrupting cash flow and liquidity.
On the face of it, dynamic discounting and reverse factoring are pretty similar. Although dynamic discounting allows buyers to offer early payments to suppliers, the buyer funds the program.
In 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 a funder, to secure risk-free returns, eliminating chances of supply chain disruptions.
To sum up, if you are looking for a solution that minimizes supply chain disruptions while improving cash flow, maybe reverse factoring is not the way to go. As the best factoring alternative option, Resolve has got you covered.
Request a demo today to see how Resolve can provide a seamless net term management solution and reduce the duration between invoice approval and payments, thus improving cash flow.