Classic factoring vs. reverse factoring – what are the differences?
The popularity of factoring has been growing steadily for years. Business financial service providers are naturally developing their portfolio, offering more and more interesting variants of the service to corporate clients. Today we will discuss reverse factoring in detail and how it differs from classic factoring.
Factoring and its types
In the past dozen years or so, we can observe the rapid development of financial services for companies. Deferred payments, installments tailored to the needs of companies, as well as diverse forms of factoring have found their way into the hands of entrepreneurs.
At first glance, it is not easy to figure out the available options. All because factories often use their own nomenclature. That’s why one service may be called full factoring, another non-recourse factoring, and another – complete factoring.
All types of the service and their categorization are described in our article: Factoring – what is it and what are its types?
Classic factoring – what is it?
At its most basic, classic factoring is a service of selling unmatured invoices for cash. It works on the basis of the so-called assignment of receivables, that is, the transfer of the right to receive payment to another company. Thus, it is particularly advantageous for companies that issue invoices with distant payment terms and do not want to wait for their counterparties to settle their obligations (often at the last minute).
There are three parties involved in the factoring process – the factor, the factor, and the recipient.
A factor is an entity that provides financing. This role is usually played by a factoring company or a bank. The factor buys the receivables (issued invoices) – takes them over from the factor and pays him the amount arising from the invoice. In doing so, it charges a predetermined commission. As part of the financing, the factor may also offer additional services, such as monitoring of receivables, assumption of risk or even collection.
A factor is a company that uses financing. It has receivables with distant payment terms that it wants to liquidate to prevent payment bottlenecks. The factor chooses factoring to assign the receivables in this way and provide an immediate cash injection in exchange for a commission.
A consignee is an entity that has purchased goods or services from a factor and has received an invoice.with a long payment term, but has not yet paid it. The role of the recipient is to agree to the assignment. In this situation, the addressee of the assignment will change – when the due date arrives, the recipient will have to pay the agreed amount to the account of the factor, rather than the original invoice issuer.
Classic factoring is a long-term solution. It involves the signing of a factoring agreement, under which the factor receives access to a factoring limit. This amount will be used to finance invoices at any time during the term of the agreement. The factoring limit is renewable. This means that – although each financed invoice reduces the available limit amount – each repayment of the obligation made by the recipient renews the available limit. In this way, entrepreneurs can benefit from financing on a continuous basis.
Classic factoring step by step
The online factoring service is simple in concept. At PragmaGO, the entire process can be described in a few points:
Step 1: contact the factor – enter the recipients of your invoices when filling out the application.
Step 2: sign the contract and get access to the Customer Zone. This is where you will submit further invoices for financing.
Step 3: you can spend the funds you receive on any corporate purpose.
What is reverse factoring?
Visible in the name of the service, “reverse” can be understood in various ways. That is why – in addition to the terms “reverse factoring” and “reverse factoring” – there is another one: purchase factoring. And it is the one that best captures the essence of this service.
In reverse factoring, the entrepreneur also takes advantage of the financing service offered by the factor. This time, however, he does not finance the receivables he owns, which he has not yet received, but the debts he has been charged with, which he has not yet repaid.
The reason on which the need for reverse factoring grows may be the same as for classic factoring. Lack of receivables paid on time often makes it impossible for entrepreneurs to pay their own debts or obligations themselves, because they have no working capital.
Reverse factoring step by step
The process can be summarized in a few simple steps.
Step 1: make corporate purchases – you will receive an invoice from the supplier as a result.
Step 2: contact a factor and use a reverse factoring service.
Step 3: transfer the liability to the seller to the factor – the latter will pay the invoice immediately.
Step 4: pay the obligation at a later date – you are bound not by the date from the invoice, but by the one you agreed with the factor.
What are the benefits of reverse factoring?
With a reverse factoring service, you will ensure your reputation as a good, timely payer. This is crucial in the process of building relationships with suppliers. It’s a long-term investment, because the better relationship you have with a vendor, the greater the chance for better terms of cooperation in the future. You can get discounts, priority service or other special benefits this way.
Reverse factoring will also enable your company to make needed purchases at a time when the prices of ordered goods are extremely attractive. Even if you don’t have working capital, you can use reverse factoring to get the goods you need immediately (and be able to continue your business unhindered). The time for payment will come later, when your counterparties settle their obligations to your company.
Classic versus reverse factoring – a comparison
The difference between the variants under discussion is contained in several important points.
First: in classic factoring, the basis of financing is the invoices issued before the entrepreneur. You sell receivables, which – at the end of the day – would have gone to your company’s account anyway. However, you get access to funds much faster and positively affect the liquidity of your business. Reverse factoring allows your company to obtain the necessary funds for planned purchases. So you finance not the invoices issued by you to the recipients, but those that your company received from the supplier.
Second: classic factoring is a service in which you assign your receivables and from then on the addressee of the payment changes. So your recipient will transfer the funds not to your company’s account, but to the factor’s account. In reverse factoring, it is your company that must settle the liability. You will transfer the funds to the account designated by the factor, and not, as the purchase implies, to the supplier’s account.
Third: classic factoring requires you to have unmatured receivables, i.e. issued invoices whose due date has not yet passed, but the service has already been rendered and the goods delivered. In reverse factoring, you submit a purchase invoice for financing even before the supplier has performed his part of the contract. In this way, you can finance purchases from, for example, online stores, which, as a rule, do not process orders without prepayment.
Fourth: under classic factoring, you receive funds directly to your business account. Using reverse factoring (purchase factoring) you gain time – in PragmaGO it’s up to 90 days to repay the obligation.
Summary
Classic factoring and reverse factoring are two diametrically opposed services. It can be said that under the purchase variant there is a role reversal. You become the payer to the factor, rather than – as in the classic version – receiving payment to the company’s account. The key feature of the service, however, is that you retain control over everything and enter into cooperation on your own terms.
