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A guide to Reverse factoring

Reverse factoring (a.k.a payables finance, Supply Chain Finance) is a technique that allows both buyers and suppliers to release working capital from outstanding invoices. Buyers get to work at attractive purchasing terms, while suppliers can receive early payment at flexible and competitive terms.

SupplierPlus operates on the Reverse factoring technique, where suppliers can sell receivables (invoices or other trade claims) to financiers without recourse. These non-recourse transactions are enabled by irrevocable debt confirmations that buyers give financiers. This guide provides an overview of the Reverse factoring technique.

* Reverse factoring has many namesakes and close relatives, such as payables finance, supplier finance, buyer-led supply chain finance, SCF-approved payables finance, etc. In its definition, SupplierPlus relies on the taxonomy compiled by the Global Supply Chain Finance Forum.

Reverse factoring offers the best of both worlds

Reverse factoring combines traits of Buyer-enabled factoring and receivables finance. Buyers confirm trade debt to financiers in a manner that shifts risk 100% on the buyer, which opens up new trade volumes for external financing - in particular for SMEs and cross-border suppliers, but also to prepayments. Financiers can now comfortably purchase receivables from suppliers at a discounted value, which allows suppliers to cash the invoices prior to the actual due date. While the cost is carried by the supplier as usual for receivables discounting, this is done at a price level that aligns with the credit risk of the strong buyer. Consequently, reverse factoring usually represents a highly competitive type of external financing for suppliers, reducing working capital costs throughout the supply chain.

Facility set up: Reverse factoring is usually deployed when a buyer sets up an SCF program, even though individual deals can also be financed this way. Suppliers are invited to join the SCF program, while they have the freedom to choose if and when to sell receivables. If sold, the receivable is assigned to a participating financier at discounted rate, while the buyer pays the full amount on the due date.

Legal structure: While the buyer sets up the facility and participates in data exchange according to a service agreement, it is not a party to the financing agreement - receivables are sold directly to the financier.

  • Buyer signs a framework service agreement with the financier to define data exchange practices and payment obligations;

  • Supplier signs a receivables purchase agreement with the financier that regulates the assignment of claims to the financier.

Risk management: Reverse factoring allows financiers to drastically reduce risks around credit, documents and fraud, which can, in turn, decrease financing costs.

Credit risk: First, financiers perform conventional credit analysis and limit opening operations on the buyer ahead of buying receivables from suppliers. Onboarding suppliers do not require credit analysis as they will only ever receive payments under reverse factoring, while they need to comply with KYC AML requirements. This check is completed by SupplierPlus.

The key instrument to mitigating credit risk is the unconditional and irrevocable payment confirmation that buyers give the financiers. These confirmations assure that the underlying receivable will certainly be paid - even if supplier risk materializes. Buyers usually give these confirmations for approved trade payables where further disputes over delivery are unlikely. Regardless, buyers retain the right to handle disputes directly with the supplier and settle affairs independently of the obligation to the financier.

Documentary and fraud risk: Risks around documents and fraud can be mitigated via data exchange methods as well as contractual obligations. As long as buyers initiate the SCF program, data usually originates from the buyer's accounting function or EDI system and only includes payables that are approved before they are made available for financing. Such approvals are grounded in a framework agreement that defines the payment obligations and unconditional and irrevocable for the purposes of external financiers. Since data originates with the buyer and is highly automated, documentary risks are almost negligible.

Risks on fraud and double-dipping are mitigated in a similar manner. High data quality and contractual obligations mean that buyers are liable for approvals and don't confirm debt to other financiers, while suppliers are permitted to sell receivables only as part of the ongoing SCF program.

Financial impact on Suppliers and Buyers

  • Enable early payment to Suppliers at competitive terms, decreasing working capital costs down the supply chain. This reduction of input costs can be put to strategic use by the Buyer.
  • Thanks to lower interest rates, the Buyer can operate at desired payment terms while the Supplier still receives a lower total financing cost.
  • Additional working capital is released for Buyers through longer payment terms (increase Days Payable Outstanding) and to Suppliers through the option to cash invoices early (decrease Days Sales Outstanding).
  • The Buyer can use the newly-generated working capital to pay down debt to reduce the financing costs (interests, transaction fees).
  • The Buyer can also use the released working capital for investments, adding to growth and profitability.
  • Regardless of how the funds are used, the buyer can optimize the balance sheet - replacing loan obligations with trade payables.

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