Factoring vs. reverse factoring – what are the differences?
Classic factoring is used by entrepreneurs who sell goods or services and cannot wait for repayment from their counterparties. Their funds are frozen, and they themselves are unable to make further investments and orders because customers are dragging their feet on repayment.
Reverse factoring takes into account the situation that may arise on the other side of the “barricade” – so the purpose of reverse factoring is to enable buyers to pay their obligations on time, as well as to help companies’ liquidity.
What is reverse factoring?
The factor, i.e., the entity using reverse factoring, may present to the factor a purchase document issued by the seller. The factor will then pay his obligation by express transfer, so the factor will keep the agreed payment date and will not damage his relationship with the seller or jeopardize the liquidity of his business.
The liability, of course, will still have to be repaid, but by using reverse factoring, the entrepreneur can do so in convenient installments. Their number and amount depends on individual arrangements between the factoring company and the factor.
EXAMPLE
Mr. Anatoly’s company purchased a large stock of chicory directly from the importer with short payment terms. The day of payment is slowly approaching, but Mr. Anatol has yet to pay three other contractors from whom he has made purchases.
Sales have been going a little worse in recent months, so the entrepreneur is unable to pay everyone, although he is anxious to keep his obligations paid on time.
In this situation, he uses a reverse factoring service – he reports the purchase invoice to his factor, the money goes to the supplier’s account even on the same day, and Mr. Anatol settles the payment on the date agreed with the factor.
How is reverse factoring accounted for?
While classic factoring is quite popular (and growing), reverse factoring is not as often chosen. One reason for less interest may be fears of improper accounting for reverse factoring. How to include reverse factoring in the balance sheet?
A reverse factoring agreement is concluded between the debtor (the entrepreneur who has an obligation to pay) and the factor. As a result, the entrepreneur hands over the purchase document (or documents) to the factor, who in turn pays them. After a contractually agreed time, the debtor is obliged to pay the factor for this service – the repayment amount is increased by the factor’s remuneration (interest and/or commission).
In the accounting books, commitment factoring transactions are entered on the liabilities side of the company. In connection with the financing of obligations by the factor, the “addressee” of the obligation changes – instead of the supplier, it becomes the factor (it is the factoring company that the entrepreneur owes money from now on).
What are the costs of reverse factoring?
Depending on the entity that provides the factoring service, its costs can vary. However, any entrepreneur using reverse factoring must expect to pay interest on the financing amount – this will increase with longer repayment terms or more installments. The interest rate on factoring installments is not high, but it often depends on the amount of financing the factor decides on.
Under reverse factoring, the factor provides the entrepreneur with a factoring limit in an amount determined at the contract preparation stage. The greater the limit, the greater the amount for business purchases available to the factor. However, it is important to keep in mind that the factor may charge additional fees for not using the allocated limit.
Other fees we may encounter are preparation fees, a commission for changing the terms of the contract or the transfer of receivables.
Important!
Remuneration to the factoring company, such as commission or interest, is a cost of the service purchased by the entrepreneur, so it can be included as a deductible expense and reduce the income tax to be paid
What does an entrepreneur gain by using reverse factoring?
Reverse factoring is perfect for many situations your company may find itself in – it’s not just an emergency type of service – when else is it worth using and what benefits of reverse factoring await the entrepreneur?
Less credit risk
A seller can give its customers long-term trade credit, but this is a risky solution and worth keeping only for trusted contractors. If we have just established a business relationship with someone, or if we want to seriously reduce the risk, we can suggest reverse factoring to the customer – the money will hit our account immediately, and the buyer will be able to make further purchases without interruption.
No negative impact on the company’s creditworthiness
Although at first glance reverse factoring may be associated with a loan, there is a powerful difference between the two: factoring is not one. Banks may refuse to provide working capital or investment loans to companies that are struggling with a standard loan from another bank. This, in turn, means that an entrepreneur who opts for reverse factoring does not thereby torpedo his company’s efforts to get credit in the future – its creditworthiness remains intact.
Image benefits
It is impossible to convert into money the benefits of paying on time and consistently building an image as a reliable business partner. And while it is incalculable, there are no downsides to this approach. A contractor that inspires trust and actually deserves that trust is, nomen omen, a scarce commodity. So consider whether, if you have temporary problems with access to cash, it’s better to wait to pay your obligations and risk worsening your relationship with the seller, or to use reverse factoring and give your counterparty the funds it owes and your company adequate time to pay.
