We’ve talked on a few occasions about the liquidity challenges often faced within the supply chain, and how this can cause an unacceptable level of risk to buyers. I recently discussed dynamic discounting as a tool for organizations to leverage their free cash to generate high, risk-free returns. While these programs have significant benefits for organizations that are willing to reduce their own DPO, they aren’t suitable for those organizations who are not able to pay suppliers more quickly.
The traditional solution for vendors looking to reduce their DSO is factoring – selling accounts receivable to a third party (ensuring prompt payment) at a discount. However, these programs often require sellers to use factoring companies for all their invoices, whether early payment is required or not.
Reverse factoring offers a flexible alternative to traditional factoring campaigns. It works by leveraging a buyer’s credit rating – usually significantly higher than its smaller suppliers – to qualify for low-cost financing of invoices, by a select group of pre-agreed banking partners.
Reverse factoring platforms work by connecting buyers, suppliers, and multiple banks to support the early payment of invoices to a company’s suppliers. They buyer will enter approved invoices into the platform, which will then automatically inform suppliers when the invoices are eligible for reverse factoring. The platform provides visibility to invoices that the buyer approves for payment, enabling suppliers to opt for early payment of the approved invoices – at a favorable discount compared to financing they could receive on their own. Once payment has been made from the banks, the buyer will then simply pay the bank on the due date.
Reverse factoring enables buyers to keep, standardize, or extend their payment terms while enabling suppliers to get early payment options through one of the buyer’s participating banks with a significantly lower discount that has traditionally been possible.
A key benefit of reverse factoring programs is that they require little administration from the buyers, once sellers have been onboarded into the program. In addition, they enable buyers to improve liquidity within their supplier base, while positively impacting their own working capital, if they choose to extend their payment terms.
Ebook: Making the business case for supply chain finance
Aite Group white paper: treasury management systems and supply chain finance
Reverse factoring case study: Auchan