Global supply chains need two things to function smoothly: consistency and liquidity. Consistency refers to the steady flow of goods, wherein the supply chain functions from top to bottom with no gluts or dearths of parts, products, or orders. Liquidity refers to the availability of capital. In order to place or fill orders, both buyers and suppliers must have available liquid assets to move forward with capital investments. For buyers, this looks like engaging a contract for the production of a product. For suppliers, this looks like purchasing the materials or manufacturing equipment necessary to fulfill a given contract. In recent years, the process of reverse factoring (also called “supply chain financing”) has found widespread acceptance in the third party logistics (3PL) space and represents a middle-market site of continuous growth. Through good faith, collaborative agreements, this process has come to represent a uniquely optimal business agreement which creates a win-win for both buyers and suppliers.
What is Reverse Factoring, or Supply Chain Financing?
Reverse factoring refers to the introduction of a third party, called a “factor,” or a financier, that is initiated by a buyer to ensure that the supplier engaged in a contract receives funds in part or in full more quickly than the terms of the original invoice. This third party has often been a bank, but in recent years, private companies have begun offering factoring services as well.
Reverse factoring contrasts with factoring, wherein the supplier requests payment from a third party. In reverse factoring, it is the buyer that engages a third party to ensure the supplier is paid quickly, while retaining their own funds until a much later date—sometimes up to 60 or 90 days. The result is that the supplier is given funds up front while the buyer retains their funds over a longer period of time, keeping assets liquid and both parties with the ability to use that cash flow in the short term.
How Does Reverse Factoring Aid 3PL Supply Chains?
The reality facing 3PL companies during the current pandemic is the mass disruption of supply chains all over the world. These disruptions create delays in payments (and potentially, defaults) which many 3PLs simply cannot withstand; most 3PLs don’t have two to three months reserve upon which they can draw in the event of a delay. This can leave 3PLs in the lurch, forcing them to deal with cash flow stoppages. Delays in invoice fulfillment is something with which 3PL professionals are well acquainted (commercial clients may request up to 90 days to pay) but when compounding supply chain challenges create greater gaps among inbound assets, 3PLs can wind up struggling to meet fixed overhead costs month to month, including facilities fees and payroll.
“These carriers need a quick pay option because they can’t afford longer terms,” says Cory Bricker, VP of corporate development for Cass Information Systems who is quoted by Inbound Logistics.1
Reverse factoring can prevent this from happening or at least lessen the severity of shortfalls. Reverse factoring incentivizes both the customer and the supplier ensuring a consistent enough cash flow that businesses are able to keep up with regular fixed costs in an industry with highly variable paydays. Strategies like reverse factoring, in their capacity to keep cash moving and available, can contribute to a corporate financial strategy which can handle small business disruptions. This resilience is always valuable to a business but is especially important now, as the pandemic exerts stress upon global supply chains. In ensuring regular cash injections, 3PLs are able to retain their workforce, continue fulfilling contracts, and weather the storm of COVID-19.
Challenges Associated with Reverse Factoring
Obtaining financing from a factor like a bank is the preferred method for many 3PL companies, but it comes with challenges. As is the case for many businesses, it’s typical to qualify for institutional financing only if a company has a sufficient, consistent enough cash flow to demonstrate the ability to repay the loan.
“We have many more alternatives now than we did … 12 years ago, when bank funding was the only option,” says Casey McClure, co-founder of Blueberry Diapers, who uses NetSuite to finance their business.1
Given the challenges facing 3PL companies, this is not always possible. As such, 3PLs may choose to partner with private third party factors that may be willing to finance a contract but may charge a higher factor fee than a bank. However, even when working through a third party factor, the financing body will base their level of involvement, if at all, on an appraisal of the buyer’s and supplier’s credit ratings. Companies with poor credit will still likely not qualify, even for a private loan.
Barring weak credit, reverse factoring remains a viable short, medium, and long term solution for 3PLs currently facing gaps in cash flow. Such factoring represents a powerful way to minimize disruptions to necessary liquidity, keeping businesses and their workforces afloat.