Recourse vs. non-recourse factoring: A cash flow comparison

As with anything that you are signing up to, it is always a good idea to know exactly what you are committing to and what you can expect in return for putting your signature on the dotted line.

Invoice factoring is a prime example of why you need to check out your options beforehand, which includes knowing whether you are being offered recourse or non-recourse factoring, and understanding the difference between the two.

Here is a look at the basic variances between the two factoring options, plus a working example to illustrate the differences. There is also an overview of how factoring companies analyse risk and a summary of how to choose the right deal.

Peace of mind or temporary relief

The fundamental difference between recourse and non-recourse factoring is what happens when an invoice remains unpaid after a certain period of time.

If you are offered recourse invoice factoring this means that if the factoring company has been unable to collect the debt by a specific date, they have the option of charging the invoice back or inviting you to replace the invoice with an acceptable alternative.

When you accept a non-recourse factoring offer, you are signing up to a scenario where the factoring company is providing you with a credit guarantee that they are going to assume full responsibility for the collection of your invoices.

What you might also get is a bit of a mix and match. The factoring company will evaluate the strength of your sales book and might decide to offer you a non-recourse option on some customers, but decline to provide the same guarantees on certain invoices that they consider might be riskier.

Having a non-recourse factoring arrangement in place is a bit like having an insurance policy against bad debt, so if you are looking for greater peace of mind, this is likely to be the preferable option if you are offered a choice between the two.

To give you an example of how recourse and non-recourse factoring actually works in practice, here are a couple of typical scenarios.

Recourse

If you sell a $5,000 invoice to the factoring company, you are offered an advance of $4,000 against this invoice and charged a 3% discount of $150 per month for the facility, that is applied for every 30 days that passes until the invoice is paid.

If your customer fails to pay the invoice within the 90-day recourse period you will owe the factoring company the $4,000 advance plus the finance charges of $450. This will be deducted from your available balance or a contra will be applied against a newer invoice.

Non-recourse

If the same $5,000 invoice was subject to a non-recourse factoring arrangement and the company fails to pay, the factor absorbs the loss and you are not obliged at that point to compensate the factor in the same way as a recourse situation.

What you need to appreciate is that non-recourse factoring will be more expensive because of the risk to the factor and the fact that they are paying for credit insurance to cover against any potential loss themselves.

They will build these insurance costs into your fee, and you also need to be aware that if the invoice is disputed and the customer refuses to pay due to what is considered to be a legitimate reason, you will revert to a recourse situation.

It’s all about the credit risk

You have to expect any factoring company to protect their interests and cover their options when agreeing to provide you with financing for your invoices.

Factoring companies are adept at analysing credit risk so they will scrutinize your book debts and make you an offer based on the perceived strength of your customers in terms of their credit rating and ability to pay.

If you have a list of customers who are all blue-chip or AAA-rated then you probably don’t need factoring in the first place. But if you are like many businesses and have a diverse mix of customers, you will be offered a deal that reflects the overall and individual risk attached to each invoice.

A factoring company is extremely unlikely to take on any unwarranted risk, or they will at least quote a fee that reflects the potential difficulties they might expect to encounter in getting paid.

Making a choice

If you are offered a choice between recourse and non-recourse factoring, which one should you choose?

You will know from experience how good your customers are at paying. If you are able to choose to factor only creditworthy customers, this will boost your cash flow and makes the prospect of non-recourse less relevant.

It is often best to talk to your factor company about your options based on your specific needs so that you get the right deal and understand exactly what you are signing up for.

Robert Bernfeld started in the commercial finance industry in 1974. His early years included positions with Aetna Business Credit and Foothill Group. During the next thirty-five years. Mr Bernfeld established both equipment leasing and accounts receivable factoring companies. He partnered in founding Business Facilitators, Inc. in 1999. Mr Bernfeld graduated from the University of California, Riverside in 1974 and received his Juris Doctorate from Loyola University School of Law in 1977.

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