Understanding Reverse Factoring in Business

Reverse factoring is a financial tool that can be a game-changer for businesses. It allows companies to receive early payment for their invoices, improving their cash flow and reducing the risk of non-payment.

This innovative approach involves partnering with a third-party financier to purchase outstanding invoices from suppliers, providing an immediate injection of cash. By doing so, businesses can avoid the lengthy payment periods typically associated with traditional factoring.

In essence, reverse factoring is a win-win situation for both the buyer and the supplier, as it enables the former to improve its cash flow while the latter receives payment for its outstanding invoices sooner than expected.

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Reverse factoring is a financial arrangement where a company selects invoices or bills from specific suppliers and a financier, typically a bank, pays the suppliers early on behalf of the company.

This process involves the financier paying the suppliers before the company has a chance to settle the invoices, which can help improve liquidity for suppliers.

The company then repays the financier at a later date, essentially extending credit terms for the company.

Reverse factoring can be a win-win for both the company and the suppliers, as it provides suppliers with early payment and helps companies extend their credit terms.

Reverse factoring is a process that involves a buyer, a financier, and a supplier. The buyer creates an agreement with the financier, which allows the supplier to receive early payment on invoices.

The financier agrees to approve invoices that the buyer owes to the supplier against an agreed fee. This fee includes a convenience fee and a pre-agreed interest rate on the outstanding balance.

The buyer places an order for the purchase of goods with the supplier, who then sends an invoice to the financier. The invoice includes the payment due date, which can be in the future.

The buyer approves the invoice, making an early payment option available to the supplier. The supplier can then request early payment on the invoice from the financier, which is a discretionary facility.

The financier makes an early payment to the supplier, deducting a small fee from the invoice. The balance is paid to the supplier.

Here is a step-by-step overview of the reverse factoring process:

1. The buyer creates an agreement with the financier.

2. The financier agrees to approve invoices against an agreed fee.

3. The buyer places an order with the supplier.

4. The supplier sends an invoice to the financier.

5. The buyer approves the invoice.

6. The supplier requests early payment from the financier.

7. The financier makes an early payment, deducting a fee.

8. The buyer sends payment to the financier on the maturity date.

The reverse factoring process can repeat as many times as needed, allowing the supplier to receive early payment on multiple invoices.

Reverse factoring is a game-changer for businesses, especially large middle-market companies in industries like construction, manufacturing, and oil and gas. It's a win-win for both buyers and suppliers.

By using reverse factoring, businesses can improve their cash flow, reducing the need for early payment requests from suppliers. This means your team will receive fewer requests to pay invoices early, giving you more time to focus on other tasks. Suppliers will also receive payment on the same day your company approves their invoice.

Reverse factoring can also help suppliers improve their cash flow, reducing the risk of disputes and non-payment. This is because a third-party financial partner is involved, and all invoices are agreed upon beforehand.

One of the key benefits of reverse factoring is the reduction in administrative work. With this service, you'll spend less time dealing with payments and managing invoices and cash flow shortfalls. This means you can focus on more critical business areas.

Here are some specific benefits of reverse factoring:

Overall, reverse factoring is a valuable tool for businesses looking to improve their cash flow, reduce administrative work, and strengthen supplier relationships.

Reverse factoring is a supply chain finance solution that targets the business/buyer, not the supplier. This approach streamlines the supply chain for both parties, benefiting both the business and the supplier.

A reverse factoring company like Viva Capital can provide a competitive advantage to businesses by maximizing their working capital. By working with Viva Capital, businesses can enjoy a stable and consistent cash flow opportunity with the quick pay option.

Suppliers benefit from improved cash-flow through faster payments, which leads to better cash flow management and improved financial health.

The presence of a factor means invoices are already agreed upon, reducing disputes between suppliers and buyers.

Reverse factoring arrangements can give rise to liquidity risk, as they concentrate a portion of an entity's financing with one financial institution, increasing the risk of a significant payment being due at one time.

This risk arises from the entity's reliance on extended payment terms or its suppliers' reliance on earlier payment terms, which could be affected if the financial institution is unwilling or unable to honor the reverse factoring arrangement.

To disclose liquidity risk, entities must provide quantitative and qualitative information about their liquidity risk, as well as a maturity analysis, as required by IFRS 7, paragraphs 33-35.

Entities must also disclose changes in liabilities arising from financing activities, which includes the classification of the reverse factoring liability as a borrowing or trade payable, as required by IAS 7, paragraph 44A.

The table below illustrates the cash flow impacts of reverse factoring arrangements when the debt is classified as trade payables or borrowings:

Entities must also disclose non-cash financing transactions, such as non-cash increases in borrowings, as required by IAS 7, paragraph 43.

Reverse factoring arrangements can be presented in the cash flow statement in two ways: as operating activities or as financing activities.

If the debt is classified as trade payables, cash outflows from operating activities appear twice for the same purchase.

When the debt is classified as borrowings and the arrangement is settled 'net', no cash outflow from operating activities is ever presented for payments of the supplier invoices.

Here's a breakdown of the cash flow impacts for both scenarios:

Non-cash financing transactions must be disclosed separately, as they do not involve a flow of cash into or out of the customer's bank account.

Additional disclosures are required when accounting for reverse factoring arrangements. These disclosures are necessary to provide users with a complete understanding of the entity's financial situation.

The entity must disclose the liquidity risk associated with reverse factoring arrangements. This is because the entity has concentrated its financing with one financial institution, increasing the risk of having to pay a significant amount at one time.

Quantitative and qualitative disclosures about liquidity risk are required by IFRS 7, paragraphs 33-35. The maturity analysis, as specified in paragraph 39, must also be disclosed.

The entity must also disclose changes in liabilities arising from financing activities. This is necessary to enable users to evaluate changes in liabilities, both cash flow changes and non-cash flow changes.

A reconciliation, as specified in IAS 7, paragraph 44A, must be presented to disclose changes in liabilities arising from financing activities. The lines items listed in IAS 7, paragraph 44B, must be included in this reconciliation.

Significant judgements made by the entity regarding its presentation of the liability as a trade payable or borrowing must be disclosed. This is required by IAS 1, paragraph 122.

The reverse factoring arrangement that is material to the financial statements must also be disclosed. This is required by IAS 1, paragraph 112(c), if it is not disclosed elsewhere in the financial statements.

Here are the additional disclosures required:

Reverse factoring may not be the best fit for every business. The biggest disadvantage is that suppliers have to work with the factor chosen by the buyer, under the terms negotiated between them.

It's typically reserved for medium to larger businesses, making it less suitable for micro or small businesses.

Suppliers also can't influence the selection or terms of this financial arrangement, which may be a drawback for some.

If you're considering alternatives to reverse factoring, there are a few options worth exploring.

A letter of credit can provide comfort from the execution risk of suppliers, and exporters can even use them to finance their cash flow problems.

For smaller importers, a letter of credit might be a more accessible option than reverse factoring.

Here are some alternatives to consider:

Reverse factoring can be a complicated financing model to understand, which may deter some importers from using it.

The biggest disadvantage of reverse factoring is that the supplier has to work with the factor selected by the buyer, and under the terms negotiated between the buyer and factor.

It's typically reserved for medium to larger businesses, making it less suitable for micro or small businesses.

This can limit the flexibility of suppliers, who may not be able to influence the selection or terms of the financial arrangement.