Factoring benefits your business in two important ways. First, factoring advances money on your accounts receivable and helps you build up cash flow. Secondly, a factoring company collects payment on those receivables from your customers. Having more cash on hand and a factor that handles collections gives you more time and money to run your company.
But what happens if a customer does not pay one of your invoices? That is where the issue of “recourse” versus “non-recourse” factoring comes into play.
Two Ways to Factor
Recourse factoring makes up most of the accounts receivable financing industry. Recourse is an understanding between you and your factor that your company must buy back receivables that the factor cannot collect payment on. You, the client, must cover the cost of any invoices your customers do not pay.
With a non-recourse account, however, the factor accepts more of the risk of non-payment by your customers.
Non-recourse factoring sounds appealing from a risk-management perspective. However, not all factoring companies take on non-recourse accounts. Those that do offer non-recourse factoring usually include several stipulations. Non-recourse factoring is more expensive, often by as much as a percentage point. For example, if a factor charges 2% on invoices funded through recourse factoring, the fee for non-recourse factoring would be 3%.
Non-recourse factoring is also limited to invoices with debtors who are most likely to pay. If the debtor has a poor credit rating and payment history, the factor will not assume the risk of non-payment.
Finally, non-recourse factoring does not necessarily protect your company from any risk of non-payment. Many factoring companies offer non-recourse that only applies if a debtor declares bankruptcy. If a debtor closes its doors or simply disappears without payment, the factoring client must still buy back that invoice from the factor.
Whether your company pursues recourse or non-recourse factoring, the best step is to sit down with reputable factoring companies and discuss their terms. It is to your advantage to find a factor that offers both recourse and non-recourse factoring. Some of your customers may be better candidates for recourse factoring than others. A factor that has a strong credit team can also help your company avoid customers that have poor payment histories.
Regardless of the type of account, a good factor goes to great lengths to collect on your invoices. Collection calls from the factor to a debtor should start 40 days after the invoice went out and continue for several weeks. After 90 days, the factor may “recourse” the invoice back to you, the client. However, the factor should provide some options for covering the cost. The factor may withhold a portion of future cash advances or deduct cash from your reserve account. Working out an unpaid invoice should not cause your company financial hardship. That is not in the best interest for you or your factor.
For more tips on choosing the right factor, read our article, “Important Questions to Ask a Factoring Company.”
The best-case scenario is for your company to have customers with good credit and solid payment histories. This enables you to pay lower fees for recourse factoring without worrying about the risk.