Payables: Reverse Factoring

What is Reverse Factoring?

From a buyer’s perspective, the preferred means of improving liquidity is to use the longest possible payment terms, i.e. supplier credits. They are recognized as trade payables in the balance sheet. The time between payment for production-related preliminary products and receipt of payment from the customer must be bridged. Using their own liquidity for this purpose can be too much for suppliers, especially if they are growing rapidly and receive numerous orders. Suppliers therefore resort to (working capital) credit lines provided by banks. But the range of instruments for generating and securing liquidity along the supply chain has expanded over time to include so-called supply chain finance (SCF) instruments, mainly due to technological progress. Reverse factoring is one such instrument. On the one hand, it enables suppliers to pay quickly, while on the other hand the buyer does not have to settle the invoice until the agreed due date.

Unlike traditional factoring, reverse factoring is initiated by the buyer rather than the supplier. In this case, customers use their creditworthiness to extend their own payment terms for their supplier invoices. Reverse factoring is implemented with the help of a third party, the financing partner. The third party receives an irrevocable payment undertaking (IPU) from the buyer. If a supplier wants to be paid earlier, he can sell his receivables to a financing partner. The financing partner charges a discount or financing discount for the purchase of the receivable(s), which is based on the creditworthiness of the buyer, the refinancing costs and the financing term. The discount is usually more favorable than the use of credit lines with banks or factoring companies. In addition, the customer’s payment risk is transferred from the supplier to the financing partner. Suppliers thus save costs for credit default insurance while at the same time receiving an immediate inflow of liquidity.

Customers have the opportunity to agree longer payment terms with their suppliers and thus improve their own working capital.

Reverse factoring thus represents a WIN-WIN situation for buyers and suppliers and helps both partners to grow together – in the spirit of a strong supply chain.