International Reverse Factoring - an innovative instrument for import business
The trend for reverse factoring is on the rise. Here, Roberto Weckop, Director, International and Marketing, for Eurofactor AG, looks at how it works and the advantages it can bring to both importers and exporters.
The worldwide growth of imports causes increasing demand for new payment solutions in a more competitive environment on the purchase side of companies. One solution could be Reverse Factoring on an international level.
Facing a constantly growing global trade of goods, companies need modern financial solutions not only to exploit opportunities in exports but also to facilitate imports more effectively. International reverse factoring provides a unique way to arrange payment terms more flexibly and to receive better purchasing terms from foreign suppliers at the same time.
The commonly used international payment methods, such as a letter of credit, can delay new business due to administrative burdens and costs. The letter of credit that the importer opens in favour of the exporter at his bank will block his credit line and require much documentation specifying the imported goods and payment terms. Only after the complete receipt of documents, will the payment to the exporter be initiated. The administrative burden of this procedure not only causes costs but can as well lead to payment delay. That again prolongs the start of new business with the respective exporter and might lead to tensions in the supplier relationship resulting in an ineffective exploitation of business possibilities.
How does it work?
In this reversed process of classic factoring, the first contact of the factoring company is the buyer of goods or services (importer) instead of the supplier (exporter). Therefore the involved factoring company (import factor) does not service the sales side but the purchase side of its client.
Hence several prerequisites are required from the importer:
Sufficient creditworthiness, a diversified supplier-structure and no corporate relations to its suppliers. There are two versions of Reverse Factoring: it can be proceeded either by the direct import procedure or, more common, by the 2-factor-system using the communication platform and the legal framework of either of the two global factoring associations Factors Chain International (FCI) and International Factors Group (IFG).
The 2-Factor process in that area is also called Reverse Marketing and is further explained in more detail:
1a) At first the importer authorises the import factor to factor its liabilities against foreign suppliers. The factor then assesses the creditworthiness of the importer up to a limit, which covers the accounts payables. The importer presents the concept to its suppliers and the import factor informs the respective local export factor to negotiate a factoring contract with interested suppliers based on the approved importer's credit line.
1b) After the export factor is informed about the credit coverage by the import factor, he can send the approved credit limit to the interested suppliers, negotiate the pricing and sign factoring contracts with each of them.
2a) The supplier sells his receivables against the respective importer to his local export factor.
2b) The export factor normally pays 90 per cent of the invoice amount immediately to the supplier. 10 percent are kept as retention for possible payment deductions of the importer.
2c) The export factor then assigns the purchased receivables to the import factor.
3a) The importer pays the full invoice amount on the due date of the invoice to the import factor.
3b) The import factor transfers the payment (reduced by possible invoice deductions of the importer) to the export factor.
3c) The export factor then pays the remaining retention of 10 per cent to the supplier (reduced by the factoring fees and possible deductions).
In case of the importer's inability to pay the outstanding receivables, the import factor is obliged to pay the invoice amount to 100 per cent 120 days after due date of the invoice (indemnification).
Win-Win situation for importer and exporter
Both parties have benefits from Reverse Factoring. The exporter receives immediate liquidity by the funding of the export factor and is protected against bad debts to 100 per cent within the approved credit limit. Hence he can export his goods to the importer on flexible open account terms and is able to expand his sales potential.
The importer on the other side can take advantage of the open account terms to improve his liquidity and purchasing conditions. He gains liquidity and improves his working capital ratio. He is able to expand the purchasing volume and profits from resulting discounts. He can develop new exporters or increase the loyalty of his strategic important suppliers. And nevertheless, the costs and administrative burdens of letter of credit procedures are reduced.
The costs of Reverse Factoring usually consist of a factoring fee that covers the protection against bad debt and the receivables management by the import factor. Regarding the funding of receivables, a common interest rate is charged by the export factor.
The international Reverse solution is interesting for importing companies who want to optimise their trade relations with existing or new exporters. Reverse Factoring can be established in nearly all industries that import goods in large quantities, particularly primary, semi-finished and finished products. Because of the increasing global trade, Reverse Factoring has an enormous growing potential in countries with high trade volumes.
The advantages of reverse factoring
Advantages for the importer
- No letter of credit (L/C) which blocks current credit line with his bank
- Cost savings and reduction of administrative burden caused by L/C
- Open account terms for the supplier payables
- Improvement of working capital ratio
- Expansion of purchasing volume
- Development of new suppliers
- Increased loyalty of strategically important suppliers
Advantages for the supplier
- Additional liquidity by funding of receivables
- Increased sales potential
- 100% protection against bad debts
- Lower financing costs due to sound solvency of importer
- Enforced relationships with large and creditworthy importers
- Improvement of balance sheet ratios by non-recourse financing of receivables (off-balance finance)