Is AR Financing Considered as Debt?

Nowadays, suppliers are always demanding for immediate payment. On the other hand, your clients are only looking to make payments after 30 – 90 days. If your business is facing issues with cash flow because of the aforementioned situation, you may want to check out accounts receivable financing. Is AR financing considered as debt? Well, it may or may not be, depending on the situation.

In general terms, factoring or AR financing is the process of converting your accounts receivable into cash through a third party company known as the factor. The factor may pay as much as 90 percent of the invoice value, and then proceeds in collecting payments from your customers for a fee. The remaining balance will be paid to you once the customers render full payment.

In this business, you may avail either the recourse or the non-recourse factoring. Knowing the differences between the two options is important because choosing one or the other may lead to the prosperity or the bankruptcy of your business.

Recourse Factoring

If you avail of a recourse factoring agreement, you are basically using your accounts receivable as collateral. Although factors are in the business of buying your invoices, they also reduce their risk by having a recourse option. In a nutshell, if your client fails to pay after the agreed amount of time, you will be the one shouldering the bills.

When this occurs, your accounts receivable may be considered as debt by your factor. Therefore, be very careful in entering a factoring agreement because according to the International Factoring Association, 79 percent of factors offer recourse factoring. You do not want your profits to turn into debt just because you did not read the fine print carefully.

To lure businesses to acquire their services, factoring companies offer credit checks to all your current and prospective customers so that you will only extend credit to clients who have excellent credit ratings. Furthermore, recourse factoring is the cheaper option between the two options since factors assume lesser risks.

Non–Recourse Factoring

If you opted for a non-recourse factoring, you are selling your accounts receivable to the factor. In this course, your business is freed from any form of debt because the factoring company completely assumes the risks.

Of course, factoring companies need to make up for carrying the risk so therefore, the discount rate will be greater. In other words, payment for your invoices will be significantly lesser compared to the recourse option.

Choosing this type of factoring option is recommended if your business relies on a few huge corporations. Although you may lose a significant amount of money if you convert your accounts receivable to cash through this route, you are protecting your business from bankruptcy. Should recession hit and one of your biggest customers becomes insolvent, you can be sure that your company will not pay the price.

Summary

With clients taking a considerable amount of time before making full payment, factoring is a legitimate option to address cash flow issues. Recourse factoring will pay you more for your invoices but if your customers fail to forward payment, your accounts receivable may be considered as debt by your factor. On the other hand, selecting the non-recourse option will pay you smaller but the factor will assume all the risks.

Understanding the differences between the two options can spell the difference between your business sinking or swimming.

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Chris Lanchech

Hi everyone, my name is Chris and I am a junior analyst at Neebo Capital and an inspiring blogger. We enjoy speaking with business owners and entrepreneurs who come to Neebo Capital looking for cash flow solutions. Give us a call toll free at 1-888-382-3766 or Visit us online at www.neebocapital.com

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