Our Early Stage Researcher Enrique Carreras (ESR 9, University of Turin) published a new article (with Lucas Figal Garone -Senior Economist, IDB Invest- and Gabriela Aparicio -Impact Officer, IDB Invest-) exploring financing alternatives in the supply chain, available in open access at the Invest division of the Inter-American Development Bank (IDB Invest): “Reverse Factoring for MSMEs: A Financial Tool for Supply Chain Development?”.

The paper discusses relevant concepts and reviews theoretical and empirical evidence related to reverse factoring, a scheme for accessing short-term credit that has emerged as a promising option for suppliers, especially micro-, small-, and medium-sized enterprises (MSMEs). Reverse factoring can potentially be a beneficial tool for both suppliers and buyers. However, there are also trade-offs which need to be carefully assessed.

What is reverse factoring?

In traditional factoring, to get quicker payments, suppliers can sell their accounts receivable to a financial intermediary in exchange for a discount, usually equivalent to an interest rate plus a service fee.

In reverse factoring, the buyer (the anchor company) is also involved in this process and provides a guarantee of payment to the financial intermediary for the supplier’s invoices, thus increasing the credibility of the payment obligation and significantly reducing the risk.

This means that with reverse factoring suppliers can sell their accounts receivable at lower interest rates, since the discount rate is based on the creditworthiness of the buyer (an anchor company with a higher credit rating) and not that of their own (usually MSMEs with high credit risk).

Top 10 findings that emerge from the analysis:

1. Win-win. Reverse factoring can benefit both anchor firms and their suppliers simultaneously.
2. Multiple benefits. The main benefits of reverse factoring may include minimizing market and coordination failures to reduce risks, optimising working capital within the supply chain, improving trust and commitment between anchor firms and suppliers, and strengthening value chains.
3. Weaker contract enforcement may lead to stronger uptake. For example, reverse factoring may be an attractive alternative in developing countries where traditional bank credit is limited due to difficulties in drawing up debt contracts, collateral enforcement, and collecting in the case of default.
4. Greater working capital needs and more MSMEs means more reverse factoring. Reverse factoring is more common in more working capitalintensive sectors and among suppliers that are MSMEs and/or more credit constrained.
5. Buyers are influencers. Adoption of reverse factoring is greater and faster if the buyer has high procurement volumes, more influence over its suppliers, and operates in an industry with longer payment terms.
6. See it to believe it. Uptake of reverse factoring by suppliers may be slow at first but increases dramatically when other companies observe the benefits obtained by early adopters.
7. Context matters. Suppliers use and benefit more from reverse factoring in the context of: (a) larger interest rate spreads in external financing and/or more constrained access to credit compared to the anchor buyer; (b) more aggressive working capital policies; (c) higher demand volatility for their products or services; and (d) higher risk-free interest rates.
8. Be careful of payment extensions. The extension of payment terms by
   the buyer while implementing a reverse factoring scheme induces a tradeoff for the supplier and therefore needs to be carefully assessed.
9. Payment extensions may work in some cases. Payment extensions in the context of reverse factoring are less harmful for suppliers in industries which already have long payment periods and when their buyers have good credit ratings and high procurement volumes.
10. Build the evidence base. While many studies highlight the potential of reverse factoring for financing MSMEs, more rigorous data analysis on the use and impact of this approach is needed both for advancing the academic and managerial literature on this topic and for designing better-targeted public and private interventions.

For more information, see “Reverse Factoring for MSMEs: A Financial Tool for Supply Chain Development?”.

Note: Work was done by Enrique Carreras and co-authors prior to the start of the SAPIENS project, and recently published by IDB-Invest.