Factoring vs reverse factoring- which benefits vendors

Factoring vs reverse factoring can be based on the parties initiating them. This article sheds light on reverse factoring vs factoring financing modes and suggests which is better for the vendor.

Difference between factoring and reverse factoring

Particulars	Factoring	Reverse factoring
Party initiating the financing	Seller	Buyer
Whose financial condition is checked by banks?	Financing limit and price mostly depend on the financial condition of the vendor or the seller	Credit limit and financing extent are based on the buyer’s or debtor’s financial strength.
Who bears the risk?	Seller	Buyer

Factoring meaning: Factoring is a financing facility in which a company sells some of its unpaid invoices to the factoring institution. The factoring institution pays 80-90% of the amount immediately, and the rest is paid when the customer makes the payment to the factoring company. The factoring institution deducts its fees while making the final payment.

Reverse factoring meaning: It is a buyer-led financing option wherein the supplier’s invoice is financed by the bank/financial institution at a discounted rate. Here, the supplier gets immediate cash, and the buyer gets more time to pay the invoice. It is an important instrument in supply chain financing as it involves the buyer, the supplier and the financial institution.

In simple words, one can say that factoring is the sale of trade receivables by the supplier to get a loan. It uses trade receivable as collateral for getting loans. But, in reverse factoring, the buyer arranges with the financial institution to make timely payment to its vendor, and the fee is borne by the buyer (usually large retailers). Both factoring and reverse factoring are important arrangements available for enterprises to fix working capital gaps.

Who owns the risk: the buyer or the vendor?

In reverse factoring, the liability of the lending institution is dependent on the buyer. Let us understand this with the help of the below illustration:

In this process, the lender has only one party to collect the payment from – the buyer. Thus, all the liability and risk is taken by the buyer.

Typical interest rates for a vendor: factoring and reverse factoring

In factoring, the interest cost is borne by the supplier. The funder charges the factoring fee, which usually ranges from 1.15%-4.5%. Also, it issues advance payment at 70%-85%. On the other hand, reverse factoring is a simple setup, and the cost involved for the vendor is low. This is because the funder is taking a risk on the large corporate buyer rather than the small supplier. The suppliers can also receive early payments, which is beneficial for their growth. 

As the buyer of goods initiates it, the lending institute’s interest rate depends on the buyer’s credit rating. All parties have clarity about when the payment will be received, so there are no delays or confusion. Thus, we can say that reverse factoring is less expensive than factoring.

Also, when one is dealing in the supply chain, anything can go wrong. So, when opting for reverse factoring, you are paid much earlier than usual. It helps to build a capital reserve which can be helpful for future potential issues in the supply chain.

Examples of factoring and reverse factoring

Let us understand classic factoring with an illustration. Company X sells automobile parts to Company Y for Rs.50,000, with payment due in 45 days. Company X owes Rs.30,000 to one or more of its suppliers in 30 days. Company X would sell the Rs.50,000 invoice to Factor Z for 90%, i.e., Rs.45,000.

Let’s now see a reverse factoring example using the same case given above. Suppose Company Y approaches Factor Z for 90% financing, i.e., Rs.45,000. Then, Factor Z pays Company X the total amount and later collects the invoice amount from Company Y on the due date.