Reverse Factoring – An Important Piece of the Supply Chain Financing Pie
Reverse Factoring is a form of receivable financing in trade finance whereby a buyer arranges for the financing of invoices raised on him by a supplier. Reverse Factoring is very similar to traditional factoring with the noticeable difference of the buyer being the arranger of the facility rather than the supplier as in traditional factoring. This feature does have some impact on risk, pricing, adaptability and so on.
There are usually three parties involved in a factoring transaction. First is the supplier who ships some goods to his buyer and raises an invoice on him. The second party is the buyer who receives the goods and is obligated to make the payment against the invoice. In reverse factoring, the buyer is usually a larger company and it can utilize its banking relationship and large balance sheet strength to arrange to finance for its supplier.
The third party involved is usually the bank. The bank is always introduced by the buyer in Reverse Factoring when he wishes to fund his suppliers.
Reverse Factoring Process
Once the buyer has introduced the bank, he provides them with a list of invoices that are due to be paid to a particular supplier. The bank then sets up limits for the buyer and since it’s the buyer who has introduced the invoices, the bank has greater confidence that he would be willing to repay them when they are due. Based on these accepted invoices, the bank approaches the supplier and can transfer the payment based on the invoice upfront. The interest component is usually deducted at this point and the amount received by the supplier is consequently lower by the interest component.
Reverse Factoring Features and benefits
- Since Reverse Factoring is initiated by large buyers with their own banks, the underlying risk is mitigated to a larger extent for the bank and they can thus offer better pricing
- The buyer can also rapidly introduce new suppliers to the bank and the same bank can quickly onboard all these suppliers and finance their invoices based on its comfort the bank
- In many ways, Reverse Factoring is similar to Supply Chain Financing with the main difference being that SCF is usually a structured product and is rolled out in a more organized and standardized way than Reverse Factoring offerings
- As the buyer is selecting which particular invoices to discount, they retain greater control in the overall transaction flow
In addition to these additional benefits of Reverse Factoring, the product still retains all the benefits of traditional factoring like strengthening of the relationship between buyer and seller, timely and realizable source of funds for suppliers, access to better information and tracking systems offered by the banks and so on.
Based on these features, Reverse Factoring is ideal for large buyers who wish to introduce one or more suppliers to their bank for cheaper and quicker funding. Bank’s always prefer products where they can establish relationships with new clients and they are usually more than willing to take additional exposure if the transaction is backed by the buyer’s Balance Sheet. Although the market for Reverse Factoring is small, it is still a great alternative in areas where formal Supply Chain Financing is not well established or there are simply not enough suppliers to go through the rather thorough process of establishing a full SCF facility.