Reverse factoring, also known as supply chain financing, is a financial arrangement where a company (usually a large buyer) arranges for a financial institution to pay its suppliers at an accelerated rate in exchange for a discount. Unlike traditional factoring, where a supplier seeks financing to advance funds on its receivables, in reverse factoring, the financing agreement is initiated by the buyer.

Reverse factoring allows firms to transfer their credit risk and borrow on the credit risk of its creditworthy customers, potentially allowing them to borrow greater amounts at lower costs.

Leora Klapper, Development Research Group, The World Bank

In Simpler Terms

Imagine you’re a small bakery supplying bread to a large supermarket chain. Waiting 60 or 90 days for payment can be tough on your cash flow, making it hard to buy ingredients and pay bills. Now, picture the supermarket setting up a deal with a bank, saying, “We’ll confirm we owe the bakery for the bread. You pay them now, and we’ll settle with you later.” 

This is reverse factoring in action. The bank pays you sooner (though slightly less, taking a small cut for the service), and the supermarket gets more time to pay. You get your money quickly, and the supermarket optimizes its cash flow.