Reverse Factoring - the new debt?
SOURCE: CHARTERED BANKER, FEBRUARY / MARCH 2010
Everyone is aware that credit is more difficult to obtain, as understandably, banks are diligently assessing the lending risk involved in connection with each borrower. Therefore, any products that potentially reduce the lending risk have to be welcomed.
The traditional method of providing funding to a Supply Chain involves the Supplier obtaining working capital, which is often secured over its assets and/or debtors. However, the reverse of this where the credit is provided to the Supplier, by a facility provided to the Buyer, is now becoming more popular, as it provides a number of advantages to each party involved.
The traditional working capital finance relied upon the credit risk being with the entity that required the working capital, which in the supply chain, is the Supplier. This would include covering the cost of supplying the goods until the Buyer made payment to the Supplier. In recent times, this period has been extended from 30 days, to 60 days, and in some cases to 90 days, and even 120 days. The extension of these payment terms has increased both the cost and risk to the Supplier. The risk to the Bank is the worth of the Supplier, and the likelihood of the Buyer making payment, which sometimes is difficult to assess. As a consequence, this type of finance is becoming more expensive, and less available.
The alternative route is for the Buyer to effectively borrow the working capital, with the Bank (as opposed to the Buyer) then making the payment to the Supplier.
In brief, the Supplier supplies the goods and issues the invoice for payment; the Buyer receives the goods and approves the invoice; the Bank then immediately makes the payment of the invoice available to the Supplier; and the Buyer is obliged to pay the amount of the invoice to the Bank by the end of the agreed payment term (e.g. 90 days). If the Supplier requires immediate payment of its invoice, then the Bank will do so, less an early payment discount; if the Supplier is content to wait until the end of the payment period, then it will receive the payment in full.
The advantages to the Supplier include that it does not have to borrow against its own resources to cover the delay in payment; it can obtain an accelerated payment if that assists its cashflow (albeit at a discount, but this will be less than the cost of borrowing); and it can place more comfort that it will be paid as the Bank is liable, as opposed to the Buyer.
The advantages to the Buyer include that it’s supplier lines become more stable (if a Supplier fails, this will disrupt the business of the Buyer); and it can extend its trade terms.
From the perspective of the Bank, it will make a return on the early payment discount that it agrees with the Supplier; the risk assessment is easier as it is against the Buyer, as opposed to the Supplier and all its debtors; and the whole supply chain will be more stable (it may bank some of the other entities involved).
Whilst this type of finance could potentially benefit a number of businesses, it will best apply to the situations where the Buyer is obtaining a significant volume of goods from regular Suppliers and where the goods are of a standard nature that can be quickly approved; it will be of less benefit to occasional Suppliers of low volume specialist goods which require to be checked in detail prior to the goods being approved.
Therefore, it is worth reviewing all customers to see if the finance ought to be provided to a different part of the supply chain, and this provide stability and working capital to benefit all businesses.
AUTHOR: alex innes