Types of Factoring Business
If you are contemplating the possibility of availing the services of a factoring business, then by now you know that invoice factoring (also known as “business factoring”) is one way of quickly providing your company with working capital. Factoring is a business transaction, during which your company gets instant cash by selling its accounts receivable invoices to a factoring firm at a discount.
There are generally two types of factoring services you can avail. The right factoring service for your company depends on who is held liable for the debts when some customers are unable to pay. The two types of factoring to consider are (1) recourse factoring and (2) non-recourse factoring.
This type of factoring is usually more preferable because the cost is generally less. The lower cost is due to your company’s decision to still shoulder the burden of bad debt instead of passing the risk to the factoring company. Because the factoring company does not take on the risk, your company should get this agreement rather quickly, as the factoring company should have less stringent rules regarding your business systems. The factoring company will also be less stringent about the payment history of your clients.
After the agreed upon time—usually 60, 75, or 90 days—your company is required to buy back the invoice from the factoring company if the customers are unable to pay. Recourse factoring is recommended if your customers are reliable about the payment, because if many of them are unable to pay then you would have to return the money paid to you by the factoring company, with the standard fees and interest.
Typical Non-Recourse Factoring
Most factoring companies define non-recourse factoring to mean that your company has no further liability for the unpaid invoice should a customer become unable to pay due to insolvency. If the customer declares bankruptcy and becomes unable to pay after the appointed time (usually the same period of time as recourse factoring), then you are under no obligation to return the advance you received from the factoring company. However, if the customer won’t pay the invoice for any reason other than bankruptcy, then even with the non-recourse factoring agreement in place the factoring company will require your company to buy back the invoice.
In this type of non-recourse factoring, the factoring company shoulders the entire risk of unpaid invoices. If for any reason the customer is unable or unwilling to pay the invoice—they don’t have to be insolvent—then the risk falls on the factoring company. If the debt cannot be collected, the loss is on the factoring company.
The sole exception to this is when the customer disputes the invoice; for example, the customer refuses to pay because your company is accused of not providing the service or product properly. Because the factoring business is outside this dispute between your company and the customer, then even with this version of the non-recourse factoring agreement you will still be required to buy back the invoice.
This type of factoring is usually more expensive and a factoring business will typically charge about 2-5% more, because of the additional risk involved.