Reverse factoring (also called payables finance, supply chain finance) is a buyer-led solution, as the initiative to work with this instrument stems from the buyer, not the supplier. Reverse factoring finances payables, helping the buyer release working capital by deferring payment terms while allowing the supplier to cash invoices immediately. The financing costs are typically carried by the supplier, leveraging the buyer’s stronger credit profile to decrease costs. This win-win situation can transform working capital management for both parties.
Getting started - how do buyers benefit from reverse factoring?
Buyers must first consider how they can benefit from financing their suppliers. By giving their suppliers access to finance, buyers can:
Payables finance programs strengthen various corporate functions but are particularly advantageous to the financial and purchasing departments.
Digging deeper – the pitfalls and how to avoid them
Securing both funding and operational capacities for reverse factoring means that the buyer should select a Reverse Factoring partner. This can be either a larger commercial bank or an SCF platform. Trade finance and corporate banks usually have reverse factoring available, but the offer is typically limited to their largest customers due to operational limitations (e.g. cost of onboarding new suppliers, inability to onboard foreign suppliers, need to ensure constant flows). More specifically, bank-led solutions narrow the scope of fundable suppliers, with many SME and complex crossborder suppliers going unserviced. It is possible to use multiple banks in parallel to increase supply chain coverage, but this duplicates processes and increases operational burdens.
Bank-friendly SCF platforms can overcome all these obstacles, allowing mid-sized buyers to leverage reverse factoring, use liquidity from funders who have suitable onboarding and currency capacities, and do so in a streamlined fashion.
In setting up its reverse factoring program, the buyer should pay particular attention to credit risk and the obligations it takes on in the process. In traditional factoring, the supplier opens a credit line with the bank and gets a loan with receivables as collateral. The buyer may or may not confirm the invoices in the process. In reverse factoring, however, the buyer confirms the debt, taking on an irrevocable obligation to pay the invoice as agreed (also called IPU, short for Irrevocable Payment Undertaking). As a result, the bank needs to open up a credit line on the buyer and expects legally binding approvals from the buyer. It is therefore wise to set limits up with multiple funders, so if credit limits are required for other purposes or pulled for any reason, other banks provide stability to the suppliers.
Credit limits will be affected by the buyer’s credit profile and payment discipline. Many funders can base their credit decisions on public data when it comes to large and reputable companies, while mid-sized buyers should be ready for additional scrutiny. Banks and platforms will request general information and detailed financial statements. Platforms allow the buyer to outsource this process by sending data once, alongside a mandate to share the information with select funders.
The buyer should also agree on data and approval exchange protocols with the bank or platform. When invoices are few and large in volume, file-based or manual information entry will suffice. If the invoice count grows and includes low-value payables, a greater degree of automation is required over APIs. Regardless, the reverse factoring partner must design and implement interoperability solutions around the buyer’s accounting systems, not vice-versa.
Though superficially complex, the process of establishing a payables finance program is actually fairly simple for buyers. The buyer needs to provide information about the financial condition and pass standard checks. Most of the technical burden is on the program provider (be it a bank or platform). The benefits, however, are significant.