Factoring is defined as the purchasing of accounts receivable at a discount. The client (the company which is seeking financing) sells their accounts receivable (invoices) to the factor who purchases (factors) the invoices less a discount. The client will gladly take less than the full face amount of the invoices immediately and benefit from the cash payment from the factor and have the factor collect from the customer (account debtor) at a later date such as 30, 45, 60 or 90 days from the date of factoring. It is a win-win-win scenario. The Client receives immediate funding to grow their business, the customer can pay on terms rather than COD and the factor earns fees for the funding services.
There are two main types of factoring – Recourse and Non-Recourse. In the case of Recourse factoring the factored invoices which are not paid to the factor by a designated number of days (such as 90 Days) are charged back to the client by the factor. Here the factor has “recourse” against the seller when an invoice it purchased is not paid by the customer within 90 days. The invoice is re-purchased by the client (or charged back by the factor). This takes place when the factor takes back the amount purchased and the fee from an available reserve of funds owed to the client by the factor or from funds due the client on the funding of other (new) invoices. The credit risk of the customer remains with client and the factor is made whole regardless.
In the case of Non-recourse factoring the factoring company assumes the risk of non-payment by your customers relating to the customers solvency. The factor performs the credit checking and approves the credit worthiness of the customer. The factor assumes the credit risk that the customer has the financial ability to pay the obligation when it came due. Here the factor has “no recourse” back to the seller for non-payment of the invoice. The factor is providing protection against the risk of credit related losses on the invoices purchased from the client.
Non-recourse does not necessarily protect the client from all risk. There are usually stipulations associated with non-recourse factoring in which the client remains responsible for customer non-payment of invoices. Examples of non-payment issues that would not covered for non-recourse would involve the delivery of defective or non-conforming goods, performance failures for services rendered such as incomplete work or defective work performed by the client. In this case the factor would still have recourse to the client as non-payment was not related to the credit worthiness of the customer (debtor).
For example, factoring companies which offers non-recourse state that it only applies if a debtor declares bankruptcy or becomes insolvent. In this case the factor will limit non-recourse agreements to debtors (customers) that have a good credit rating. The debtors (customers) with bad credit ratings (who are at the highest risk of non-payment) are not eligible to be factored. Here the factor is making credit decisions for their benefit as well as the clients. The factor is essentially saying this is not a good risk for us and therefore not a good risk for the client. The client should arrange for cash payment in advance or by credit card or avoid selling to the at-risk customer altogether. Due to the credit protection provided in non-recourse agreements they typically have a higher factoring rate than recourse factoring arrangements.
For more information on Recourse vs Non-Recourse Factoring or other inquires as to how factoring can benefit your business contact:
Advance Capital Solutions LLC
dba ACS Factors