What is reverse factoring?

To guarantee their liquidity and improve cash management, companies can adopt the reverse factoring . It's an effective way of mitigating the negative effects of extended payment terms. Although it is not the most widespread approach, it can still be considered because of the benefits it brings.

In this article, we tell you all about this financial operation.

Reverse factoring: definition

Reverse factoring, also known as "affacturage inversé" in English, is a form of factoring in which the factoring process is carried out by a third party. a financing method used by companies to improve their cash flow by optimizing supplier payment terms.

More clearly, it's a financing technique that enables a company to pay its suppliers more quickly and at lower cost, by involving a financial organization (the factor) which advances the funds to the suppliers and is reimbursed by the company later.

This technique offers advantages for the company, which can negotiate discounts with suppliers and improve cash flow, and for suppliers, who can reduce their working capital requirements and secure their payments.

Reverse factoring is generally used by large companies, purchasing groups or industrial groups with sales in excess of €20 million. However, the technique is starting to become more popular with smaller companies. On the other hand, other invoice financing solutions, which offer greater freedom and flexibility, seem to be more suitable for them.

The difference with conventional factoring

Conventional factoring and reverse factoring are two financing techniques that enable a company to transfer its invoices to a financial organization (the factor), which pays them immediately in return for a commission. The difference between the two techniques lies in initiative and factor selection criteria.

In traditional factoring, the company selling the invoices (the supplier) takes the initiative and contacts the factor. analyze solvency of the company's customers (the debtors) and set an outstanding limit for each customer. The factor also handles debt collection, reminders and guarantees against non-payment. In return, the factor receives a commission on each successful transaction, or a cash advance.

In reverse factoring, it is the company that has to pay its invoices (the debtor) that takes the initiative to contact the factor. The factor will then analyze the company's solvency and set an overall limit on outstanding amounts, and offer to pay the company's suppliers on the due date, in exchange for a discount. The factor will be reimbursed by the company at a later date (when the invoices are due or according to the terms agreed between the two parties).

How does it work?

First of all, when a purchasing company forwards a batch of invoices from its suppliers, it includes an "irrevocable" payment order to be settled on the agreed date . This irrevocability means that the buyer undertakes to make the payment even if he identifies, before the due date, a problem justifying a partial or total blockage. It is only thanks to this irrevocability of the payment order that the factor can offer the supplier risk-free financing.

The factor then sends suppliers a payment notice on the due date, accompanied by a "non-recourse" assignment of receivables contract within 24 to 48 hours. The term "non-recourse" indicates that the factor waives the right to claim reimbursement from the supplier in the event of the customer's insolvency before the due date . Only this "non-recourse" feature enables the supplier to remove assigned invoices that are not yet due from his accounts. Suppliers usually have a choice of two assignment methods:

• Automatic financing of all invoices issued.

• Assignment on a case-by-case basis.

Next, the factor makes transfers to the supplier from a shared account in the name of the purchasing company . On the due date, whether or not the supplier has chosen to finance its receivable, the buying company is debited by the factor. Depending on the terms of the contract, the supplier may be granted an additional period agreed with the factor. If the supplier has opted to finance his receivable, the factor invoices the purchasing company for the financial charges corresponding to the period of the cash advance.

Finally, the supplier who has received payment in advance grants his customer a financial discount in the form of an early payment discount.

What are the advantages of reverse factoring?

Reverse factoring offers different benefits depending on the parties involved. Let's look at the benefits from different perspectives.

For the supplier

By adopting reverse factoring, the supplier guarantees cash payment upon delivery of the goods . This speed of payment offers a significant advantage in optimizing cash flow. The supplier can also benefit from a larger short-term credit, but limited to the amount of invoices issued to the customer who has set up this financial arrangement.

In addition, reverse factoring contracts generally include clauses stipulating that the factor cannot claim against the supplier in the event of non-payment by the customer.

What's more, this type of short-term financing can prove more profitable than conventional factoring. In fact, remuneration is based on the level of risk of the only debtor assigned, i.e. the client company.

For the buyer

Opting for this solution enables the buyer to maintain payment deadlines and good relations with suppliers . In addition, repayment terms to the factor may be longer than those to the original supplier.

By complying with the objectives set out in the French law on the modernization of the economy (LME), buyers benefit from a useful tool for building loyalty among their main suppliers. They can also negotiate better payment terms, which leads to a reduction in working capital requirements. It can also optimize margins through discounts.

In addition, this flexible, scalable solution offers three key advantages to companies outsourcing their accounts receivable management:

• Transformation of fixed costs (reminders, collections, etc.) into variable costs

• Optimizing and improving administrative management (follow-up, reminders and accounting management)

• Secure financial management (cash flow and prevention of non-payment risks)

For the factor

This method of financing also offers advantages from the factor's point of view compared with conventional factoring. In reverse factoring, credit risk is focused on a single customer which is highly solvent. In conventional factoring, on the other hand, this risk is spread over a large number of customers whose solvency often varies.

Finally, it is important to note that in this overall situation, the buyer has the opportunity to present an innovative solution through a "triple win" negotiation.

What are its drawbacks?

Reverse factoring also has its drawbacks, particularly for the corporate customer who initiates the process. Here are some of the disadvantages of reverse factoring:

• It involves an additional cost for the customer who has to pay a commission to the factor to finance its supplier invoices. This cost can be significant over the long term.

• It requires sufficient solvency of the customer company who must repay the factor on the due date. If the client company encounters financial difficulties, it runs the risk of not being able to honor its commitments.

• It imposes coordination between the customer, its suppliers and the factor, who must agree on the terms and conditions of the reverse factoring contract. Suppliers must also agree to transfer their invoices to the factor, which is not always the case.

• It limits the freedom and flexibility of the client company, which must comply with the terms of the reverse factoring contract. For example, it cannot take out other loans or change its suppliers' payment terms without the factor's agreement.

Why use reverse factoring?

The company adopts reverse factoring for a number of reasons, including making immediate payments to suppliers. This allows you to negotiate discounts on orders.

What's more, the commercial benefits of this technique are often more significant than the costs associated with reverse factoring. What's more, by shortening payment times, the company strengthens its image in the eyes of your suppliers.

Finally, reverse factoring reduces suppliers' working capital requirements by enabling them to deconsolidate their invoices without risk. With reduced WCR and an improved financial situation, suppliers will be more inclined to work with your company.

How do I set it up?

Are you convinced of the benefits of reverse factoring and want to implement it in your company? Put your trust in Hero our payment and financing platform dedicated to B2B transactions.

Created in 2020, Hero is particularly aimed at VSEs and SMEs . We've told you that reverse factoring is a technique primarily designed for large accounts. However, Hero makes this technique accessible to small and medium-sized businesses.

It's a payment platform that implements deferred payment, in other words, a reverse factoring system that doesn't say its name. In practical terms, the supplier delivers to the buyer, who can then pay after 30 to 60 days . On the other hand, the supplier is immediately reimbursed by the platform.

In reverse factoring, Hero acts as a factor. It pays itself a commission when the buyer pays the invoice in full.

What's more, Hero is an easy-to-use tool which lets you manage all your transactions and make repayments at the click of a button.

In conclusion, reverse factoring is an advantageous financial method for companies. It fosters stronger relationships between suppliers and customers, improves cash flow and offers negotiation opportunities. As a result reverse factoring plays a crucial role in optimizing financial flows.

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