Recourse and Non-Recourse Factoring: Know What You Are Signing
Factoring is a financing option that small and medium enterprises adopt to ensure adequate financial supply. A factoring company buys the accounts receivable of a company and handles the paperwork of what it purchased. It is usually done without notifying customers about the state of their accounts. When a company factors, it assigns its invoices to a third party and is funded for an agreed portion of those invoices.
Factoring is considered the last-gasp option that entrepreneurs can use when there are no other means of securing funds. It does, however, help to reduce certain internal costs. There are two types.
Recourse factoring. This is less expensive than non-recourse factoring. You sell your invoices to a factoring company that takes responsibility for collecting them. If the client does not pay, the factoring company will recover the cost from you, or request another invoice of the same value.
The advantages of recourse factoring are that it is a way of generating quick cash, it does not appear as a loan on the company's balance sheet, your connections do not have to be actively involved, and it improves your cash flow.
Non-recourse factoring. This is not common among businesses. It differs from recourse factoring because if the client does not pay, you do not have to repay the factoring company. Whether it counts as non-recourse depends on the cause of the client's inability to pay, such as bankruptcy or closure, and this has to happen within the stipulated 90 days of the factoring period. One perk is that it is free of credit risk.
Before signing off on a non-recourse agreement, make sure you read the agreement thoroughly. The protection it offers depends entirely on the conditions written into it.