Recourse factoring is a financial solution used by businesses of all types in many industries. It provides relief in times of tight cash flow or business seasonality. Businesses can often see their invoices funded (minus a fee) in as little as 24 hours in some cases.
The concept of recourse factoring is simple. It is defined as the act of selling accounts receivables at a discount, with the promise of purchasing them back if the customer does not pay. Most factoring arrangements are of the recourse type because it provides greater protection to the lender. Should an invoice go unpaid, they can turn to you for payment.
On the flip side, recourse factoring usually has lower fees because your business carries the credit risk. This can be ideal if you have a portfolio of customers that are trusted and reliable.
What happens if the customer doesn’t pay?
This is usually accomplished through trading another receivable to cover the cost, reducing future payments, or through an established reserve account.
When you trade a receivable to account for another one that went unpaid, you are simply trading a “good” invoice that can be collected to replace the “bad” one. The good invoice must be of equal or greater value to cover all of the incurred fees associated with factoring.
Reducing future payments
Your lender may choose to reduce your future payments to cover the costs of an unpaid receivable. This is the easiest way for the transaction to occur, and is one of the most frequently used. It is important to note that this may not be a preferable option for small businesses that don’t have many outstanding invoices at any given time. There simply may not be enough money due to cover the default immediately, which will likely lead to additional interest and fees.
Establishing a reserve account is a common practice among recourse factoring companies. You may be required to fund the account initially upon beginning your relationship. It can also be funded from your first transaction, or from multiple transactions. The system in place varies widely between factors. The size of the reserve account is usually determined by your average volume and invoice amount.
What are the advantages of recourse factoring?
Each situation is different, but recourse factoring can help your business in many ways. The primary benefits include:
- Quick access to funds (Can see an invoice funded in as little as 24 hours)
- Easier to obtain than conventional lending
- More flexible than a loan
- Lower fees than other types of factoring
- Can be a cheap form of leverage if your customers are reliable
What are the disadvantages of recourse factoring?
There are some other disadvantages that come along with recourse factoring. They include:
- Requires greater discretion when extending credit
- High fees compared to a loan or line of credit
- May have to fund a reserve account up front
The bottom line
- Recourse factoring has lower rates than factoring without recourse.
- You have to pay back the factoring company if they can’t collect on an invoice
- May be required to tie up capital in a reserve account
Recourse factoring is the most common type of invoice funding available. It’s a useful tool that has a place in virtually all industries. The points made above should help you come to a decision when determining which financial product is right for your specific needs.