A Supply Chain Theory of Factoring and Reverse Factoring

Abstract

Factoring is a financial arrangement where the supplier sells accounts receivable to the factor against a premium, and receives cash for immediate working capital needs. Reverse factoring takes advantage of the retailer's payment guarantee and the credit rating differential between small supplier and large retailer, enabling the supplier to receive financing at a more favorable rate. We develop a supply chain theory of (recourse/non-recourse) factoring and reverse factoring showing when these post-shipment financing schemes should be adopted and who really benefits from the adoption. We find recourse factoring is preferred when the supplier's credit rating is relatively high, while non-recourse factoring is preferred within certain medium range of ratings. Both factoring schemes, if adopted, benefit both the supplier and the retailer, and thus the overall supply chain. Further, we find that reverse factoring may not be always preferred by suppliers compared to recourse and non-recourse factorings. Retailers should only offer reverse factoring to suppliers with low, but above a threshold, to medium credit ratings. The optimally designed reverse factoring program can always increase the retailer's profit, but it may leave the supplier indifferent to current factoring option when followed by an aggressive payment extension. More importantly, contrary to conventional wisdom, our theory implies that reverse factoring could be adopted even when the retailer has no credit rating advantage over the supplier, and could benefit the retailer even without extending payment terms.

Keywords: Supply chain finance, recourse/non-recourse factoring, reverse factoring, accounts receivable, credit rating, credit risk, liquidity risk, payment extension