Invoice factoring means that an external force (the factor) buys another entity’s accounts receivable or invoices from the client company. Thus, the client can get his or her money sooner so that he will not need to wait for the customer (the debtor) directly.

No debt is issued or acquired by the parties participating in a factoring arrangement. Therefore, factoring is not a loan. Because of this, factor finance is rapidly replacing traditional debt as a preferred alternative funding method. It has been essential for many SMEs since it encourages new business endeavors and boosts economic development significantly.

Two Types of Factoring

Both recourse and non-recourse factoring exist, and any entrepreneur worth their salt should be familiar with both. However, we need a broad understanding of each before analyzing them to determine their relative merits. We will now define them:

Recourse Factoring

Recourse factoring encourages clients to repurchase overdue bills from the factoring business. Customers could benefit from debt factoring, selling their outstanding debt to a factoring business at a discount to pay off their overdue debts.

Suppose your responsible client does not pay within the stated period. In that case, your factoring business has two options: either have them charge you back for the invoice or replace it with an invoice that is unfunded. You take on more of the non-payment risk when working with a factoring business. When accounts receivable are factored with recourse, the client, and not the factor, is liable for paying off overdue customer payments.

Non-Recourse Factoring

If the client's creditors fail to pay, the factoring business will shoulder most of the financial burden. As a result, they will demand further reductions on outstanding bills. The main point is that your business is not liable for clients who do not pay under certain circumstances.

One thing to remember is that the customer can still be in danger. Provisions are related to non-recourse factoring. When debtors file for bankruptcy, most factoring firms will provide non-recourse loans only.

To be eligible, however, such debtors must have high credit scores. The factoring business promises to collect your bills as part of their credit guarantee. However, they do not guarantee to safeguard you from customers who question the quality of your products or services.

In recourse, the factor absorbs your customers’ non-payment risk.

Examples

As an example of recourse factoring compared to non-recourse factoring, consider the following scenario: “Cup or Cone” is a new ice cream business that has negotiated Net 30 payment terms with ABC Groceries, another current vendor. Cup or Cone has major financial issues since ABC Grocery does not pay its invoices on time, even on the second payment cycle.

Cup or Cone collaborates with altLINE to increase working capital and recover from cash flow issues. Cup or Cone and altLINE have entered into a contractual agreement to handle recourse factoring, and from now on, ABC Grocery will pay altLINE directly for their invoices.

Sadly, ABC Grocery goes through the motions again, but this time they don't just miss the payment deadline; they completely ignore the invoice. The party responsible for the non-payment will be Cup or Cone, as they were involved with the remedy. Cup and Cone are both aware that this was beyond their control, thus altLINE is collaborating with them to find a workable alternative until payment is received. However, if ABC Grocery does not submit payment, either Cup or Cone will be obligated to repay altLINE the whole amount of the cash advance.

Advantages and Disadvantages: Recourse vs Nonrecourse Factoring

Cash flow challenges are something that even prosperous firms face, particularly those with extended payment cycles, as explained in an article. Most businesses that are impacted by this will turn to factoring as a way to get the money they need. Which option is ideal for your company? That is the main question. So, before making a final choice, it's wise to do a recourse vs nonrecourse factoring comparison.

Advantages of Recourse Factoring

The most prevalent form of factoring, known as factoring with recourse, has many benefits:

• Facilitates rapid access to funds for pressing expenses.
• There is no need that the client to deal with collections.
• Due to lesser element costs, this alternative is cheaper for invoice sellers.
• Increases the money from bills, which helps the company's cash flow.
• Review and approval time reduced.
• To reduce the possibility of defaults, the factor is responsible for conducting thorough credit checks and verifications of invoicing customers.
• In default, the customer can repay "bounced" bills or have them swapped for others.
• In order to assist with the client's recourse costs, the factor may make available solutions.
• Since it's not a loan, the client's balance sheet will not reflect any debt.

Disadvantages of Recourse Factoring

Nobody likes to make a hasty decision without fully understanding the potential consequences. To sum up, the main drawbacks of factoring with recourse are as follows:

• The client's debtors are subject to looser credit checks, which means the factor has less risk and may have recourse in the case of non-payment.
• A client's company revenue and bank accounts might be negatively impacted if they do not pay the default immediately or offset it with a positive invoice.
• The price of an invoice presented as payment for an unpaid one is greater.

Advantages of Non-Recourse Factoring

Advantages of non-recourse factoring is that it is defined by:

• Superior protection against bad debts for the customer
• Improves operational capital and cash flow
• Debtors might be given payment conditions by clients.
• In order to reduce the possibility of defaults, the factor is responsible for conducting thorough credit checks and verifications of invoicing customers.
• Far less difficult to get than other options, such as a company line of credit (LOC)
• Easy to use and quick to roll out
• Could be available for a three-month loan at the most

Disadvantages of Non-recourse Financing

Here are a few downsides that should be considered:

• Companies have different levels of bad debt protection.
• Rigid procedures may be required prior to financing bills due to non-recourse considerations.
• Expensive compared to other financing options, according to bank finance
• Requests a further reduction on bills

Bottom Line: Recourse vs Nonrecourse Factoring

In conclusion, before deciding between recourse and non-recourse factoring, a customer should have an in-depth conversation with a respectable factor to determine the latter's terms. Ensuring debtors have excellent payment histories and high credit scores is usually the greatest way to avoid risk and spend less on fees.