Dynamic Discounting and Reverse Factoring - pros and cons

Here I have listed the pros and cons for Dynamic Discounting (DD) and Reverse Factoring (RF). There are related blog posts available from the list of  "Labels in Blog" far down in the right column of this page.

This list is developed from a practible corporate treasury perspective. The aim has been to cut through any  sales pitches from the vendors. It is not necessarily the case that you implement either DD or RF. There are situations when both can be applicable in parallel or different solutions applicable in different geographical areas and jurisdictions. Hope this grid is helpful.

Factors to consider	How the factors affects each solution
	Reverse Factoring (RF)	Dynamic Discounting (DD)
Decrease DSO (days sales  outstanding) for Suppliers	Yes	Yes
Attractive financing terms for the Suppliers	Yes. This is the main argument for RF, the less creditworthy Supplier can use the higher rated Buyer’s credit terms, benefiting from lower interest rates and, with approved invoice, higher amounts that can be borrowed	Not necessarily. DD’s main argument is for the Buyer being able to exploit the restricted financing capacity of its Suppliers, offering typically 2% flat for 20 days faster payments. The Buyer can thus use its free cash to improve its yields. DD is in this respect an improvement of early payment (static) discounts where many times the payment arrived late but the discount was anyway taken off the amount
Time and Date secure collection	A very good argument for the Suppliers since it provides predictability of the collections and facilitates liquidity planning. Even large Suppliers with no particular need for the extra financing can choose RF for this reason. May improve rating and save money on reduced lending
On- or off balance sheet treatment, i.e. decrease of working capital for the Buyer	This is possible in RF however it has some requirements i.a. Buyer’s arms’-length relation to the banks’ lending to the Suppliers	Highly unlikely this will be anything other than on-balance. Decrease cash holdings and AP
Decrease working capital for Buyer, that is removing payables from the balance sheet (decreasing DPO)	Yes, if requirements of arms’-length to banks providing the loans is fulfilled	No
Full automation of P2P (purchase to pay) process	This is a requirement
Repair need of P2P process	Full automation decreases the risk of error and late payment and extra costs for repair of payments and/or bookings. Requires fully standardized processes
Suppliers have the flexibility to choose which invoice to be requested for earlier payments	Yes, BUT in this solution many (smaller) suppliers may have collateralized all its receivables to one bank making it difficult to “sell” individual invoices to the Buyer’s bank	Yes
Supplier on-boarding	Historically a problem since RF is a very complex solution and many times hard for procurement and Suppliers to grasp. Many stakeholders create a risk of delays and obstacles in the on-boarding. Important to remember RF is not only an IT rollout. RF is often expensive to maintain	Easier than RF but still requires IT connectivity, education of the Suppliers and set-up of internal administrative processes for support and requires IT rollout
Changes in lending capacity of the Buyer affecting the financial strength of the supply chain and Suppliers’ funding may be jeopardized	Can happen if e.g. the bank(s) are not able to provide sufficient funds, or attractive interest rates. Another reason can be that the Buyer gets downgraded or the banks want to reduce the exposure to the Buyer.	DD in its most basic form uses the Buyer’s cash and no banking facilities. The risk is that the Buyer’s cash headroom is not sufficient at all times for funding. Just consider in a situation when the Buyer makes a significant acquisition. Does the DD challenge the cash head room capacity?
Suppliers acquire new behavior	The suppliers get used to this financing alternative and have no short term backup facilities. This means that the Buyer cannot expect to easily withdraw from this SCF program. It can not be regarded as a swing line facility
Banks’ involvement	In RF the bank prefers the Buyer to use the bank’s own proprietary solution but a bank independent platform can be an alternative. One shall be aware that the banks sometimes regard the bank independent platforms as competitors, which may inflict on the solution’s efficiency	DD is still uncharted territory for most banks. They are a bit concerned they will be left out. I have not yet heard of any banks providing solutions or special credit facilities for DD
Payment method	I believe the Seller shall only pay interest or discount from the date she or he has the amount available on its account. Payments shall therefore be some sort of wire transfers, checks are so much 20 century and such a silly payment method that it can not belong in fully automated processes. A success factor for a supply chain solution is that the Buyer does not try to delay payments from agreed terms. That is not a serious way of doing business. Remember that the Suppliers are usually the weaker part having the biggest relative financing burden
Applicability to local legislation	Must be analyzed and can provide stumbling blocks. Factoring or invoice discounting are regulated differently dependent on jurisdiction. A particular problem if RF does not allow off balance treatment according to local legislation	Should not provide a problem since it is only early payments from Buyer’s cash account

Please let me know if I've missed out on something and I will add or correct. Thanks