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Recourse factoring, along with non-recourse factoring, are the two main types of invoice financing.  Often used by businesses who struggle with cash flow issues, invoice factoring works by allowing businesses to get paid quickly without having to wait for days or weeks for their customers to settle what they owe. Unpaid invoices are viewed as assets because they represent money that is owed to a business, and certain finance companies are willing to purchase the debts from businesses that then benefit from quicker payments and improved cash flow.

That’s the basic principle of invoice factoring, but it does get a little more complex. In this article, we look at how recourse factoring works, and explain what makes it different from non-recourse factoring. Keep reading to find out whether either of these options could be the right move for your business.

What is factoring, and what are the types of factoring?

Invoice factoring is a form of financing that allows businesses to borrow money against the amounts due to be paid by customers. It can help businesses to improve their cash flow, pay their employees and suppliers, and reinvest into their operations without having to wait for liquidity as payments roll in.

Invoice factoring, in addition to invoice discounting, is a form of “accounts receivable financing” or “receivables financing”. It comes in two main varieties:

  • Recourse factoring; and
  • Non-recourse factoring.

What is factoring with recourse and without recourse?

Invoice factoring, both with recourse and without it, involves exchanging the outstanding invoices owed to your business for money in the here and now. They both serve to achieve the same purpose but that’s where the similarities end.

The most common form of invoice factoring is with recourse, and that means your company is obliged to buy back any invoices that the factoring company is unable to collect payment for. The reasoning is that the invoices are to your clients, you have the relationships, and your business is responsible for any non-payment.

Contrastingly, non-recourse factoring involves the factoring company taking on most of the non-payment risk associated with an invoice.

How does non-recourse factoring work?

As explained above, non-recourse factoring involves a factoring company purchasing the outstanding invoices owed to a business. This means that the business gets the money it’s owed upfront, whilst the factoring company will attempt to collect payment for the outstanding balance. Unlike recourse factoring, non-recourse factoring sees the finance provider assume most of the risk for any non-payment of the debt, meaning that if the customers don’t pay, your company won’t usually be obliged to repay the financing company and take responsibility for collection.

Non-recourse factoring is usually only available to businesses with a good credit rating, or for those who are at risk of bankruptcy where it might not be possible for them to assume responsibility for any non-paying customers. It also has the potential to have higher costs attached, meaning that businesses may not get as much for the invoices they ‘sell’ as they would with recourse factoring.

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Which type of risk does a non-recourse factor assume?

Many people assume that non-recourse factoring will protect their company against non-payment of invoices in any circumstances. This is a common misconception, and in fact it’s the case that non-recourse factoring only protects against a select range of non-payment events. For many factoring companies, their assumption of risk for non-payment is only limited to situations in which the customer becomes insolvent during the factoring period.

This means that your business will assume the risk for any non-payments unless the customer becomes insolvent within 90 days from the date on which the factor purchases the invoice. Some factoring companies limit their definition of ‘insolvency’ to cases of declared bankruptcy, however others are willing to offer more flexible plans.

What is a recourse obligation?

A recourse obligation is a contractual requirement for a business to take back the risk for non-payment of a factored invoice. This can usually be satisfied by repurchasing the account from the factoring company or substituting a non-paying account with a new factor without receiving any additional payment.

Businesses that use recourse factoring may be required to take back responsibility (both financial and operational) for any sums that are not paid by their clients.

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How do factoring companies work?

Third-party companies, known as factors, are the financial providers who buy an interest in the outstanding invoices held by a business. The factoring company gives the business money upfront and takes on responsibility for collecting the invoice payments.

Factoring companies often buy invoices in two instalments. Firstly, they will provide a factoring advance that covers around 80% of the receivable amount. The remaining sum, minus the factoring fee, will be paid once the client settles the invoice in full.

What is the difference between recourse and non-recourse?

Recourse factoring involves a company selling their invoices to a factor, who then becomes responsible for collecting the outstanding sum. If the customer doesn’t pay, it falls to the business to cover the cost.

Non-recourse factoring, on the other hand, is a way of protecting against ‘bad debt’. In certain circumstances, non-payment of an invoice will not be passed back to the business who took out the non-recourse loan and they will not become liable for the outstanding amount.

Who offers non-recourse loans?

Non-recourse loans are less common than recourse factoring, but they are still available to businesses with a good credit rating or where a company is concerned that their customers may become insolvent before paying them. They often come at a higher cost meaning that businesses using non-recourse factoring often get less money in return for their outstanding invoices.

BusinessComparison provides a way for businesses to quickly find the best invoice finance solutions for them, including recourse and non-recourse loans. To start comparing invoice financing options, simply visit our comparison page and fill out the quick and easy business information form.

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