What is reverse factoring?

Reverse factoring, also known as supply chain financing or reverse invoice factoring, is a financial arrangement that allows businesses to improve their cash flow by accelerating the payment of their invoices. In traditional factoring, a business sells its accounts receivable (unpaid invoices) to a third-party financial institution, known as a factor, at a discount in exchange for immediate cash. However, in reverse factoring, it is the buyer of the goods or services who initiates the process.

Here's how reverse factoring typically works:

1. Supplier sends an invoice: The supplier delivers goods or services to the buyer and issues an invoice as usual.

2. Buyer approves the invoice: The buyer reviews and approves the invoice, verifying that the goods or services have been received and meet the agreed-upon terms.

3. Buyer requests early payment: Instead of waiting for the standard payment terms (e.g., 30 or 60 days), the buyer requests early payment to the supplier.

4. Financing arrangement with the factor: The buyer's request for early payment is facilitated through a financial institution, which acts as the factor. The factor agrees to pay the supplier the invoice amount, minus a fee, in exchange for the buyer's commitment to repay the factor at a later date.

5. Supplier receives early payment: Once the financing arrangement is in place, the factor pays the supplier the invoice amount, typically within a few days.

6. Buyer repays the factor: On the original payment due date specified in the invoice, the buyer repays the factor by settling the invoice amount.

Reverse factoring benefits both the supplier and the buyer. The supplier receives early payment, which helps improve its cash flow and reduces the need for external financing or borrowing. The buyer, on the other hand, can optimize its working capital by extending payment terms while ensuring that the supplier receives timely payment. Additionally, reverse factoring can strengthen the supplier-buyer relationship by providing financial stability and reliability.

It's important to note that reverse factoring should not be confused with traditional factoring, as the roles and payment initiation differ.