Supply chain financing is a set of financing tools that allows a company to improve its cash flow. The most common tool in the supply chain financing tool set is reverse factoring. However, there are other tools such as supplier financing and purchase order financing.
Invoice factoring, on the other hand, is a trade financing solution, although it could arguably be called a supply chain financing tool as well. It is a tool that allows companies to improve their cash position by financing their accounts receivable.
In this article, we compare invoice factoring, reverse factoring, and supplier financing to determine which one is better.
1. What is invoice factoring and how does it work?
Slow invoice payments from customers are a common problem for companies that need to extend 30- to 60-day payment terms. Invoice factoring solves this problem. Factoring is a financing tool that allows small companies to finance their accounts receivable.
The factoring company finances your accounts receivable and provides your company with liquidity. Most plans are flexible and allow you to choose which customers you want to finance. A key advantage of this program is that your ability to factor is determined by the credit quality of your invoices – rather than the credit quality of your company. This advantage makes factoring an ideal option for small and growing companies. For more information, here is an explanation of how factoring works.
Invoice factoring is considered a post-delivery financing tool. In other words, to qualify for financing, the product (or service) must be delivered and accepted by the client.
2. What is reverse factoring and how does it work?
As its name implies, reverse factoring is much like invoice factoring, but with a change in how the service is configured. Instead of having small companies looking to factor their invoices, a large company decides to offer a reverse factoring accommodation to its suppliers. The large company offers reverse factoring as a way to help its suppliers with net 30- to net 60-day payments that they have to make.
If you are the supplier of a large client that offers reverse factoring, you have the option to get paid on usual terms, or to request a quick payment. A finance company intermediates the quick payment transaction and provides you with the funds. The supplier pays a small fee for the service. Ultimately, the supply chain finance company waits for the client to pay the invoice in full, once the invoice matures.
Like conventional invoice factoring, reverse factoring is a post-delivery financing tool. You can request a quick payment on an invoice only after you have fulfilled it.
3. What is supplier financing and how does it work?
Supplier financing is a tool that helps manufacturing companies and product distributors that need help building inventory or fulfilling large orders. It works by having a supply chain finance company act as a purchasing intermediary between your suppliers and your company.
When you need to buy products (or raw materials), you place the order with the supplier financing company. The supplier finance company agrees to sell the goods to you on credit. Then, the finance company buys the goods from your supplier and has them delivered to your company. Supplier financing provides you with the goods you need to build your inventory or fulfill orders.
The last step of the transaction occurs when the supplier finance company issues an invoice (on net terms) to you. The transaction settles once you pay that invoice at maturity.
For more information, here is how supplier financing works and who qualifies for the service.
Unlike factoring and reverse factoring, supplier financing is a pre-delivery assistance tool. It can provide the resources to deliver and order goods and, consequently, grow your business.
4. Which one is better?
The better solution for you depends on the financial problem that you are trying to solve. Each of these options has advantages and disadvantages.
If your cash flow is tight because your clients are paying slowly, invoice factoring is probably a better solution than reverse factoring. While invoice factoring is more expensive than reverse factoring, it gives you the control to finance as many clients as you need.
Reverse factoring, on the other hand, allows you to get quick payment only for invoices of that specific client. The reason for this limitation is that the client is the one offering the accommodation to its suppliers – as a way to help them.
Supplier financing is the better option if you need help buying products from your suppliers because you are trying to build inventory or fulfill a large order. You do not need an invoice to finance and you do not need to post any collateral. It’s similar to getting additional credit from your suppliers.
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Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.