Reverse Factoring vs. Supply Chain Financing

Amid supply chain disruptions and economic uncertainty, many buyers have extended payment terms with their suppliers in order to preserve working capital. But this approach can quickly backfire: Without prompt payments, suppliers may face cash flow problems and the entire supply chain can suffer.

A mutual buyer-supplier need to access cash has led to the widespread use of reverse factoring or supply chain financing. As a supplier, you might have heard of these solutions — and others, such as invoice factoring — but be unsure of what they are.

Here, we explain the differences and similarities between these terms and cover ways you can maintain a healthy cash flow without taking on more debt.

Reverse factoring vs. supply chain financing: Is there a difference?

Reverse factoring and supply chain financing (SCF) are two different terms that describe the same thing: The buyer uses a third-party lender to fund early payments to suppliers. Here’s how it typically works:

1. A buyer partners with a lender, either a bank or fintech company, to fund a reverse factoring/SCF program and invites you, the supplier, to participate.
2. The buyer submits a purchase order to you.
3. You deliver on the order and send the buyer an invoice for the goods or services provided.
4. If you choose to participate in the program, the lender pays your invoice early in exchange for a discount on the total amount owed.
5. The buyer pays the lender in full within their agreed terms.

The aim of reverse factoring and SCF is to give both buyers and suppliers easier access to working capital. By using a lender to fund early payments, the buyer retains cash for longer without impacting your cash flow and potentially weakening the supply chain. By getting invoices paid early, your business experiences improved cash flow. 

Lenders for these programs assess discount rates based on the buyer’s credit rating rather than yours. This means that reverse factoring and SCF only make financial sense if your buyer’s credit rating is stronger than yours. In this case, the cost of a discount in exchange for early payment is often competitive against other working capital solutions, such as business loans. Plus, supply chain financing doesn’t require you to acquire additional debt.

Invoice factoring is not the same as reverse factoring

Reverse factoring, which is synonymous with supply chain finance, often gets confused with invoice factoring. However, invoice factoring and reverse factoring are distinct practices.

The main difference between the two is that invoice factoring is initiated by the supplier and reverse factoring is initiated by the buyer. With invoice factoring, you sell your outstanding invoices to a factoring company, also called a “factor,” for a portion of the invoice total — usually 70% to 90%. The factor then collects payment directly from your buyer and gives you the remaining amount minus factoring fees. These fees typically increase the longer it takes the factor to settle payments.

Whereas reverse factoring is a mutual agreement meant to benefit both you and the buyer, invoice factoring is simply a service that advances you cash based on your accounts receivable. Some other key differences include:

• Cost. Traditionally, invoice factoring is associated with high costs and hidden fees. Depending on the program, reverse factoring may be more affordable, especially if the buyer’s credit score is strong.
• Accessibility. Invoice factoring is relatively easy for suppliers to implement. On the other hand, traditional reverse factoring programs can be hard for smaller suppliers to access due to complex onboarding and financial agreements prohibiting participation.
• Buyer relationship management. Because factoring companies take over payment collection processes in invoice factoring, suppliers lose control over that aspect of buyer relationships. This isn’t an issue with supply chain financing because the buyer initiates the program.

Early payment programs offer an alternative cash flow solution

Suppliers often address cash flow issues by getting a business loan through a bank or alternative lender, applying for a business line of credit or seeking outside investment. But these solutions take time and can be costly — especially as interest rates rise. For many suppliers, leveraging a buyer’s supply chain financing program is a more affordable, accessible and timely option for sustaining cash flow.

However, not all reverse factoring agreements are created equal. As mentioned, some programs are inaccessible to smaller suppliers due to cost, resource-intensive onboarding and restrictive agreements. Because reverse factoring terms are determined between your buyer and its lending partner, you also have little control over which invoices to accelerate and at what cost.

Thankfully, fintech companies are rethinking traditional supply chain finance models to give you and your buyers more flexibility when coordinating early payments. For example, early payment programs are buyer-initiated but exclude a third-party lender. Instead, these programs typically use an online platform to coordinate win-win early payment terms. As a supplier, you decide which invoices to accelerate and set an acceptable discount rate. When the discount is agreeable to both parties, your buyer funds early payment directly. This approach has several benefits:

• Programs are typically quick and easy to implement.
• You have more agency over early payment terms than you would through traditional reverse factoring agreements.
• Programs are funded and set up by your buyer, alleviating the need for you to sign contracts or take on added costs (aside from the discount itself).
• Some programs use dynamic discounting, a flexible early payment model that adjusts the discount based on when the buyer pays.

The bottom line on reverse factoring vs. supply chain financing

Reverse factoring and supply chain financing both describe a buyer-lender partnership that funds early supplier payments. This process differs from invoice factoring, in which a supplier sells outstanding invoices to a factoring company.

New early payment programs offer a modern spin on reverse factoring and SCF, making early payments easier to access directly from your buyers. If you’re considering this solution, investigate whether any of your buyers already offer such a program to suppliers. Before participating, make sure you understand how early payments are funded, which terms you have control over and whether the program offers user support for suppliers.

Interested in a more flexible way to access working capital that puts you in control? Click here to learn more about buyer-initiated early payment programs.