In a typical factoring arrangement, it is the provider of services or goods that will be the party that contacts and reaches out to a factor to purchase it’s invoices. In factoring terminology, that is the client and it is party that has invoiced for goods or services performed and is also the party that is waiting to get paid. For example in a construction-based transaction, a sub-contractor that has provided services such as electrical work in a new building, submits an invoice for payment to the general contractor on the job. The general contractor, however, must wait to get it’s progress payment from the bank or funding company on the project before it can pay the electrical sub-contractor. This delay, of up to 60 or even 90 days can cause serious cash flow problems for the sub-contractor. By purchasing the invoices of the sub-contractor, it is now the factor who waits and through it’s sale of invoices to the factor, the sub-contractor now has adequate capital to operate. That example is traditional factoring in a nutshell.
In a Reverse Factoring arrangement, or as it is often called supply chain finance, it is the customer of the supplier, the company required to pay the invoices, that contacts the factor to arrange for early payment to it’s suppliers. For many large corporations, managing financing methods and avoiding late payments to important and valuable suppliers can become a challenge for even the most creditworthy of manufacturers and retailers. One solution that many businesses (often large companies) have turned to is reverse factoring.
How Does Reverse Factoring Work
As mentioned, unlike a traditional factoring arrangement where a supplying or services providing business owner will contract with a factor for early payment to solve cash flow problems, in a reverse factoring arrangement…
- a buyer, through the normal course of business, purchased goods and services from it’s suppliers
- the buyer, requests the services of a factor so it may offer early payment to it’s valuable suppliers
- the buyer is sent invoices as normal from its suppliers which it subsequently reviews for accuracy and validity
- the buyer requests early payment from the factor on invoices it approves and for those suppliers requesting the early payment option
- the supplier typically is charged a factoring fee for the early payment
- the buyer pays the factor the face value of the invoice on the arranged invoice date
The key to establishing a reverse factoring arrangement is the creditworthiness of the buyer. By definition, such arrangements are considered transaction which involve issues of concentration risk, since the factor’s advances of capital to all of the various suppliers opting for the service, are repaid by a single entity, the buyer. The buyer, therefore, must be of stellar credit and in most transactions, the buyer will be a relatively large company.
Benefits of Reverse Factoring
There are many benefits to establishing a reverse factoring arrangement for the supplier, the buyer, and also the factoring broker if one is involved.
For the Supplier
- Lower Funding Costs: Suppliers could naturally set up their own factoring arrangement but the fees charged would be based on their credit. In a reverse factoring arrangement, the fees paid by a supplier are usually much less since the creditworthiness of their buyer will typically be very strong.
- Increased Working Capital: Since the supplier’s invoices will be paid immediately rather than being forced to wait 45, 60, 75 days or longer, the supplier’s working capital position will improve.
- Inventory Replacement: Immediate payment on finished goods means that inventory and raw materials can be replaced more quickly and, in some cases, even with discounts.
- Reduced Administration: The supplier’s accounting personnel will no longer need to request “early payment” from buyers due to special circumstances and working capital shortfalls.
For the Buyer
- Increased Working Capital: As with suppliers, funding by the factor can significantly increase working capital. This is especially true for manufacturers with occasional delays in receiving key components required in the manufacturing process
- Payment Flexibility: Flexibility of payment to the factor when unforeseen interruptions in the supply chain present themselves.
- Better Relationship with Suppliers: Buyers can establish much better relationships with their suppliers and the early payment can sometimes lead to better pricing on services and components.
- Less Administrative Work: Buyers are now paying a single entity, the factor.
Benefits for the Broker
For savvy brokers well versed in the uniqueness of reverse factoring transactions, landing such deals can increase your commission business exponentially since the success of establishing the transaction will mean the creating of many supplier accounts. The importance of this cannot be underestimated since although the commission revenue will be based on a factored invoices of a single buyer, once the various suppliers of that buyer are introduced to the factoring concept and its many benefits, most will begin factoring their invoices for other customers which can grow your brokering dramatically. In short, you should understand the considerable benefits of reverse factoring (supply chain finance) and look for opportunities to present the concept to your larger, creditworthy prospects.
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