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Recourse factoring versus Non-Recourse Factoring

Recourse factoring versus Non-Recourse Factoring

Factoring overview

Factoring also known as debtor financing and receivables factoring that is commonly used for domestic trade financing as well as international trade finance. Factoring is a process using which a business can sell to a financial institution the value of accounts receivables for which it has not received payment yet. For obtaining the cash it needs right away, the business is supposed to sell the value of the accounts receivable (generally due within 90 days) to the financial institution (which is commonly referred to as the “factor”) at a certain discount, creating the opportunity for the factor to access profit. The discount given is usually between 10 to 20 percent.

Key points

  • It is simple to approve funding process
  • Provide payment terms for customers
  • Smoother cash flow in terms to aid financial planning
  • Eliminate bad debt risk and overhead costs
  • There are no financial covenants

What is recourse factoring?

Recourse factoring can be seen as an agreement where a company sells its current invoices to the third party or a factoring company with the understanding that the company will buy invoices back if in case they go uncollected. This recourse factoring plan is generally affordable as the company agrees to absorb some of the risk that will be involved in the transaction.

Recourse factoring can be considered as an agreement between the seller and the factor. In this type of factoring, the company is responsible to recover the cost of invoices which the liable buyers fail to pay. It means, if the customer does not pay the invoice within the specific time, the Factoring Company can revert back or can charge that invoice back to the seller, or that invoice can be replaced with another good invoice.

What is non-recourse factoring?

Non-recourse factoring allows a company to sell its unpaid invoices to a factoring provider without the obligation of absorbing any unpaid invoices. Instead, if the clients renege on their payments or even pay their invoices after due date, the involved losses are absorbed by the factor, that too leaving the business unscathed.

In Non-recourse factoring, the factor accepts the credit risk of non-payment of your customers. Businesses which don’t get qualified for the Recourse Factoring can take Non-recourse Factoring into consideration. Thus, the Factoring Company will assure you with a credit guarantee that they will be responsible for the collection of invoices on seller’s behalf. It might be all your invoices or just those from certain clients. Generally, this guarantee is valid in case your buyer files for bankruptcy. This is not a guarantee against your commodities rather this is an “insurance policy” against bankruptcy which can be critical for your survival.

Benefits of recourse factoring

  • It provides you with fast cash for your business immediate needs;
  • Is not considered to be a loan thus, there will be no debt on your balance sheet;
  • You will not have to handle any collections;
  • Helps in stimulating business’ cash flow.

Benefits of non recourse factoring

  • Provides you with same day funding;
  • Available working capital along with better cash flow;
  • No extra debts i.e. It is a debt free transaction;
  • No credit risk is involved as you don’t have to pay if the invoice isn’t paid by the buyer.

Which type of factoring is better?

Both have their own advantages and disadvantages; however, if your customers are creditworthy, then there will be minimal risk involved in either type of factoring. When you have to choose between the two, you will have to determine which will be much better and suitable as per your company’s financial situation.

It you want that there should be no credit risk and with this you want to save money then you must go with non-recourse factoring. Non-recourse factoring will be the best solution, as it is the less risky for your business. When you are looking for ways that will work its way out of debt, then you must go with recourse factoring.

Recourse factoring vs non-recourse factoring

Recourse factoring Non-recourse factoring
Business accepts the liability for unpaid invoice Factoring company accepts the liability for unpaid invoice
Much relevant in terms of cost Higher fees
High advantage rate Low advantage rate
No help on disputes Help with disputes
Credit risk is borne by client Credit risk is borne by factor
Typical rates from 1% to 3% Typical rates from 4% to 5%