What is reverse factoring and why you should care

Cash may be king but cash-flow is the lifeblood of business – particularly small business. Payment terms have long been a concern for suppliers as different customers offer settlement on any range from pay-as-you-go to 20-30 or even 90 days. The past couple of years have seen the rise of what is referred to as ‘reverse-factoring’, essentially if you want to be paid sooner you sacrifice a portion of the invoice amount (get paid earlier but get paid less).

So what is it really? Traditional factoring is best described as a business selling its accounts receivables to a third party who then chases the money, in this case, it is the supplier who takes a haircut on the amount that they are owed in exchange for early settlement. Reverse factoring in contrast is initiated by the purchaser who offers to pay their debts through a third party on a sliding discount.

Why is it in the news? This week Rio Tinto and Telstra publicly announced that they would scrap their reverse factoring arrangements and in the case of Rio, commit to paying small suppliers on 20 day terms (for suppliers with turnover up to $10m). In contrast, the largest user of the scheme in Australia, CIMIC has committed to its use.

Should you be worried? The payment scheme is not widely adopted and in only really beneficial to very large organisations – it may well be the cost of dealing with some customers. This doesn’t mean that it is fair. Also, it is criticised by some in financial circles as it may distort a companies balance sheet effectively ‘hiding’ the true nature of its debts.

At the end of the day the practice is here to stay at least in the medium term.