Reverse factoring is when a finance company, such as a bank, interposes itself between a company and its suppliers and commits to pay the company's invoices to the suppliers at an accelerated rate in exchange for a discount. This is a lower-cost form of financing that accelerates accounts receivable receipts for suppliers. This approach has the following benefits for the company that is paying its suppliers:
- The company can foster very close links with its core group of suppliers, since this can be a major benefit to them in terms of accelerated cash flow.
- 100% of the invoice value is available for factoring, rather than the discounted amount that is available through a normal factoring arrangement.
- The company no longer has to deal with requests from suppliers for early payment, since they are already being paid as soon as possible.
Reverse factoring has the following benefits for suppliers:
- A cash-strapped supplier can be paid much sooner than normal, in exchange for the finance company's fee.
- The interest rate charged by the finance company should be low, since it is based on the credit standing of the paying company, not the rating of the suppliers (which assumes that the payer has a good rating!).
The finance company acting as the intermediary earns interest income on the factoring arrangements that it enters into with the suppliers of the target company. This can represent an excellent source of income over a long period of time, so bankers try to create sole-source reverse factoring arrangements to lock in this source of income.
Reverse factoring is typically available to those suppliers with which a company has established a long-term trading relationship.
Reverse factoring is usually begun by large companies that want to improve the cash flow situation for their suppliers. To convince a finance company to be involved in the arrangement requires the expectation of a considerable amount of factoring, which is why this approach is not available to smaller companies.
There are on-line systems available, on which a company can post its approved invoices, and which suppliers can access to select which invoices they want to have paid to them earlier than dictated by the standard payment terms.
Reverse factoring is the same as supply chain financing.