Many businesses struggle with cash flow management. This is a common problem among small and startup companies, but many larger established businesses struggle with it as well. Not only is poor cash flow a warning sign of early business failure, but damaging relationships with customers and suppliers can also send a business spiraling downward.
As a result, many businesses often resort to loans or liquidating assets and/or inventory to pay suppliers. However, there may be an easier way to ensure the health of your business: reverse factoring.
Read on to learn more about how reverse factoring works, and how it can help your business grow.
How Does Reverse Factoring Work?
Let's first define reverse factoring: Reverse factoring involves a finance or lending institution—also referred to as a “factor”—which serves as a third-party intermediary between a business and its supplier. The financial institution or factor agrees to pay the company’s invoices to suppliers at an accelerated rate and collect customer payments for a fee.
Here is an example of how reverse factoring works:
- The funder or “factor” purchases the outstanding invoices from the company and manages payment collections from the customer
- The factor then advances 70% to 95% of the paid amount of invoices to the business and holds the outstanding amount
- Once all customer payments are collected from the customer, the buying company must pay the factor minus the factor’s fee
The ultimate goal of reverse factoring is to accelerate accounts receivables and increase cash flow for businesses. Reverse factoring is a cost-effective form of financing that has proven to help solve cash flow problem for many companies. Instead of a company factoring customer invoices, it factors supplier invoices and accelerates accounts receivable receipts for suppliers. In doing so, the company is factoring part of the supply chain. Reverse factoring is an accounts payable solution.
What Are the Benefits of Reverse Factoring?
Here are some of the top benefits of reverse factoring for businesses and suppliers:
- Improved Cash Flow. Because factors pay invoices to suppliers faster, businesses no longer have to wait for accounts receivables. This leads to increased cash flow and better cash flow management, which are crucial to the overall financial health of an organization.
- Reduced Early Payment Requests. With invoice factoring, businesses no longer have to deal with early payment requests from suppliers. With the presence of a factoring agreement, suppliers are already paid as soon as possible, or according to their payment terms.
- Reduces Disputes. In addition to early payment requests, businesses will also minimize payment or invoice disputes with suppliers. Because a factor is involved, invoices are already agreed upon, and suppliers do not have to worry about non-payment or fraudulent invoices.
- Suppliers Are Paid Sooner. Suppliers will always know when they can expect payment, which reduces the number of long, unnecessary delays.
- Low-Interest Rates. Lower interest rates are charged by the factor and are based on the creditworthiness of the buyer company, not the rating of the suppliers.
- Less Administrative Work. Businesses that have a factoring agreement in place will find that they spend less time performing administrative work, particularly involving chasing payments and managing invoices. This means that businesses can spend less time chasing payments, allowing them to focus on more critical areas of business growth.
- Reduced Liability. With a funder or factor keeping up with invoices and payments, the overall liability for the buyer company is reduced. Additionally, a small amount of liabilities improves a company’s balance sheet, allowing the business to acquire lower interest rates on loans.
- Develop Long-Term Relationships. In many cases, relationships between businesses and suppliers are quickly due to late payments or non-payments. However, in a factoring agreement, suppliers and businesses can build and develop long-term relationships with suppliers, allowing firms to also expand partnerships with larger corporations.
Who Uses Reverse Factoring?
Many different types of businesses can benefit from reverse factoring. Reverse factoring is usually best for larger businesses. This is because a considerable amount of factoring is involved in convincing a finance company or funder to be involved in a factoring agreement.
As a result, many businesses must prove their creditworthiness before being considered for factoring arrangements. This is another reason why reverse factoring arrangements are typically a good fit for larger businesses. Small businesses are often seen as a higher risk for these types of agreements.
Although factoring agreements are certainly a viable option to pay or finance suppliers on time in order to keep operations moving smoothly in the organization, it’s still important for businesses to properly manage cash flow.
To learn more about reverse factoring, check out our Beginner’s Guide to Reverse Factoring.
Are you caught in a cycle of constantly Factoring or Reverse Factoring? Apruve can help you get an advance on your supplier invoices and allow you to set better terms for your customers. Apruve makes accounts receivable processes much easier for large enterprise merchants, by customizing a credit and AR automation program best suited for their organization. Learn more about Apruve or contact Apruve’s specialists to sign up for a demo today!