If you’re considering factoring your receivables, you’ve probably come across many different types of factoring services. It can quickly get confusing, so it’s important to know exactly which service is right for your business. Two of the more common choices are recourse and non-recourse factoring. In this article, we’re going to go over the later.
What is Non-Recourse Factoring?
Non-recourse factoring is when a business sells it’s receivables to a factoring company without the obligation of absorbing any losses from unpaid invoices. In this type of arrangement, the credit risk is transferred to the factoring company that purchases an invoice. Should a customer default on their payment, the business is not liable to return the funds to the factor.
How Does it Differ from Recourse Factoring?
In a recourse factoring arrangement, a business maintains the credit risk of their customer when factoring their receivables. In other words, if the customer doesn’t pay, you’re required to pay back the funds to cover the losses. This is usually done through a reserve account established by the factor.
When factoring without recourse, you aren’t required to maintain a reserve account with your factoring company. This is because you will not be liable to pay back the funds of any defaulted invoices. Consequently, recourse factoring usually requires a reserve account to be funded and established. The size of your reserve account is usually based on your average invoice amount, and your customer’s credit risk.
Nonrecourse invoice financing is almost always more expensive. This is because a company is effectively wiping it’s hands clean of the credit risk, and transferring it to the purchaser of their receivables. A flat-rate percentage is usually charged, which makes it easy to determine exactly how much you’ll receiving in funding. Most spot factoring services charge flat rate fees, and are usually a non-recourse arrangement.
What Does Non-Recourse Really Mean?
When considering a non-recourse factoring service for your business, it’s important to determine what exactly is covered when the factor assumes the credit risk. Many agreements might only cover specific circumstances, such as your customer filing for bankruptcy or becoming insolvent. Any other reasons for default may not be covered.
In other words, some instances or occurrences may require your business to repay the factoring company. These can be events such as:
- Invoice or payment disputes
- Worsening of a customer’s credit profile
- Breach of contract by your business
- Other credit related problems or events
You should carefully examine your factoring agreement prior to committing so you know exactly what is covered.
Advantages of Factoring Without Recourse
There are many advantages to using this type of service. They can include:
- Lowering internal accounts receivable/collections expenditures
- Can alleviate credit risk, depending on the agreement specific
- Allows your business to grow
Some disadvantages to factoring without recourse that you should be aware of:
- Your factoring company will likely have stricter credit requirements for your customers
- Higher cost
- Exact coverage may vary and will require in depth examination to determine
Is it Right for You?
Non-Recourse factoring is a great choice for businesses that need an influx of cashflow to grow or sustain their operations.While the costs are usually higher, factoring without recourse allows you to focus on running your business; not chasing down customers for payment.