Reverse factoring

What it means

Reverse factoring is started by the buyer, not the supplier. The buyer approves the invoice to the bank, the bank pays the supplier ahead of the due date at a discount, and the buyer settles with the bank on the original date.

Unlike ordinary factoring, the cost of the funding follows the buyer’s credit standing rather than the supplier’s. A small supplier therefore gets money more cheaply than from its own overdraft.

For the supplier it is usually a non-recourse sale of the receivable: the risk of non-payment lies with the bank, which relies on the buyer’s approval of the invoice. Once paid, the supplier therefore closes the receivable in its books and shows no loan in its place, which is what distinguishes it from simply drawing an overdraft against invoices.

How it works in practice

The programme runs through the buyer’s bank: the supplier signs up to a framework agreement and every invoice is an assignment of a receivable to the bank. The buyer’s approval of the invoice is irrevocable.

Where the programme also stretches the due date of invoices, the auditor asks whether the liability has become bank debt. Reclassifying it lifts net debt and can breach the covenants in other agreements.

When a client joins a programme as supplier, we match the bank’s payment in the open items ledger against the invoice issued to the buyer and book the difference as a finance cost. VAT is unaffected: the taxable amount stays the invoice total, because the discount is the price of the bank’s financial service, not a rebate to the buyer.

What to watch out for

Stretching payment terms from thirty days to ninety looks like a cash flow gain. The discount is borne by the supplier, though, and in the accounts the payable moves into financial debt, so the saving is lost again on the lending ratios.

A supplier that gets used to early money builds its whole cash flow around it. The buyer or the bank can end the programme under the contract, for instance when the buyer’s credit standing worsens, and the supplier then has to bridge long payment terms overnight from its own overdraft, which the bank is under no obligation to grant.