Supply chain finance is far from being a new form of working capital financing, however, the types of products currently being offered have evolved over time and recently, “Reverse Factoring” has been increasing in popularity with corporates. It hasn’t been without controversy though, with reports suggesting that some large companies (including CIMIC, Inghams, Rio Tinto and Telstra) have been using Reverse Factoring to extend payment terms whilst at the same time offering suppliers an option for early payment of invoices through a supply chain financier (at a cost). The disclosure of these arrangements in financial statements has also been called into question. Notably, Telstra and Rio Tinto have recently announced that they were pulling back from their Reverse Factoring arrangements.
What is Reverse Factoring?
Reverse Factoring is effectively a form of working capital financing that allows a Purchaser to “extend” its working capital cycle and a Supplier to “shorten” its cycle by funding invoices through a third party financier. The transactional flow is set out below:
Why are companies looking to Reverse Factoring as a financing solution?
Working capital management can be complicated and optimising the cash conversion cycle takes a concerted effort from Management teams. There are a number of levers that can be used to improve performance, but extending supplier terms is often considered a last resort given the stress it can cause across a company’s supply chain, resistance from suppliers, and broader reputational risks.
However, Reverse Factoring has been positioned as a win – win for Purchasers and Suppliers in that they both can achieve a working capital benefit, facilitated by a third party Financier.
What are the arguments for and against Reverse Factoring?
| Working capital benefit for both Purchaser and Supplier.
The Purchaser can “extend” its payment cycle through longer terms, while the Supplier can “shorten” its collection cycle.
| Cost of benefit is passed onto the Supplier, who may not get the opportunity to price the cost into their supply arrangements.
The Supplier is effectively signing up to a line of credit with an interest expense.
|Supplier has access to cheaper finance based on creditworthiness of Purchaser.|
| Purchaser leverages market power to impose extended terms on their Suppliers, who may not have the ability to negotiate.
The Supplier may arguably be put in a position where it has no choice but to accept the new extended terms, resulting in the Supplier being worse off (lower net payments and margins).
| Additional administrative burden on Suppliers to claim through third party Financier.
Along with the added “paperwork”, matters may be further complicated by having a third party involved with respect to any disputes, returns, credit notes and adjustments to invoiced amounts (that may occur from time to time).
| Current Accounting Standards do not have explicit rules around disclosure.
Reverse Factoring is often used as a form of “off balance sheet” financing for companies, which makes it difficult for users of financial reports to properly understand the financial liabilities, financing arrangements and covenants, and underlying risk profiles.
We always advocate for our clients to look for opportunities to optimise their working capital management and to “shorten” their working capital cycle and increase cash flow, however, it is important (particularly for large businesses), to work collaboratively with other business in their supply chain to ensure this is done in a sustainable manner. Working capital and supply chain financing solutions can be an effective tool, provided the costs or discounts are properly understood and modelled, and are borne by the appropriate party.