Like many things in business, this isn’t a new idea. I clearly recall signing secrecy documents in order to take part in discussions with a bank in 1997 about how a new factoring model that would leverage the flexibility of the internet. It would transform trade credit. More opportunities emerged early into the new century but it wasn’t until the last couple of years – 10 years after I first confronted reverse factoring, that I’ve seen it implemented as a real business tool. That why it’s OK to call it new and now is an opportune time to look at it again.
Factoring is a traditional tool. It allows businesses to ‘sell’ their outstanding invoices to their bank. The bank will take a fee, advance a proportion of the value of the invoices (typically 75%) and chase for payment. This is an effective tool but for a small business with not a lot of financial clout, it is expensive. Reverse factoring allows even small businesses to take advantage of the financial standing of their customers to get a better deal.
Instead of presenting a stack of invoices to the bank, the supplier works in collaboration with a single customer at a time. They pass the invoice to the customer as usual who then authorises payment. This changes the status of the invoice – it make it more valuable and on the back of this, the bank is prepared to advance cash to the value of the invoice (minus a handling/credit) charge. The key here is that the bank assesses the financial standing of the customer when setting the fees – not the supplier – so for small businesses with large customers, reverse factoring can make sense for all parties.
Click the flash animation to see how it works