Supply chain factoring, which is more popularly known as reverse factoring, is the process by which suppliers sell their invoices at a discount to third party organizations such as banks or other financial service providers, like factoring companies. Unlike other methods of factoring, supply chain factoring is usually initiated by the buyer and not the seller. This is mainly done when the buyer wants to make sure that the supplier has the necessary amount of funding needed to continue with their roles while they await payment for the invoice.
How Does It Work?
Reverse financing typically happens with four stages. First the seller will transfer the purchased goods plus the invoice that details the entire transaction to the buyer. Once the buyer has received the invoice, they will go through it, make sure that everything is in order and then transfer it to the third party, in this case the bank or another financial organization.
At this point the bank will conduct their due diligence and then notify the supplier once they’ve confirmed everything is in order. After receiving the notice, the supplier has the freedom to choose whether they will want the payment immediately or would rather receive it later.
At this stage the earlier the supplier receives the payment the higher the discount will be so most of them would rather wait for an extended period in order to incur a smaller discount. The buyer will then settle their account at a later date as agreed with the bank.
It is worth pointing out that the whole process is reliant on the third party and buyer’s relationship with each other. If the third party is confident in the buyer’s ability to pay back based on their previous encounters, then there is a higher chance of the reverse factoring request being accepted.
Advantages To the Buyer
- For starters, it improves the buyer-supplier relationship. Many suppliers like when buyers fulfill their payments as early as possible as it allows for a smoother cashflow. Therefore, when a buyer goes to the extent of involving a third party just to remain on the good books of the supplier, then their relationship is set to flourish.
- Secondly, when the third-party financier pays the invoice at an earlier point, the supplier is the one who incurs the cost in form of a discount and not the buyer.
- There is a stable supply chain. When suppliers are promptly paid for their services, they are able to maintain a steady cash flow which in turn allows them to continue with their business uninterrupted.
- Another upside to supply chain factoring is the way it enables the buyer to extend payment terms without necessarily having an impact on the financial stability of the supplier. The buyer gets to have their cake and eat it.
Supply chain factoring is one of the few financing methods that are instigated by the buyer. However, it is worth noting that the agreements vary depending on the parties involved so suppliers should be on the lookout for any clauses that may disadvantage them.