Invoice factoring is the process by which a business sells its outstanding invoices to a factoring company for cash. There are many benefits to invoice factoring. For example, it allows businesses to obtain money very quickly instead of waiting for clients to pay their invoices 30, 60 or 90 days (or more) after goods or services are rendered. Even though a business must sell its invoices to a factoring company for slightly less than the value of each invoice, the business receives its cash quickly and without any hassle.
The two most common types of invoice factoring are “recourse” and “non-recourse.” While they are very similar in principle – e.g. both provide the business with immediate cash – one places a higher level of risk upon the business, and the other places a higher level of risk upon the invoice factoring company. It all comes down to “bad debt.” If an invoice purchased from a business by an invoice factoring company is never paid – who will cover it?
When businesses choose recourse factoring, it means they have agreed to sell their outstanding invoices to an invoice factoring company with the understanding that if the invoices are never paid, the business must cover the cost. In other words, the factoring company is guaranteed payment – if not from the customer via the unpaid invoice, then by the business that sold the invoice to the factoring company. With recourse factoring, there is very little credit risk to the invoice factoring company. The business selling its invoices to an invoice factoring company via recourse factoring does receive the benefit of an immediate influx of cash, but the business must agree to cover the cost of unpaid invoices within a set period of time. Every invoice factoring company that offers recourse factoring has a contract with its own unique set of terms and conditions, but typically, invoices that are not collectable must be repaid by the business within 90-120 days.
With non-recourse factoring, a higher level of risk falls on the invoice factoring company. When an invoice factoring company makes an agreement with a business to purchase its outstanding unpaid invoices via the non-recourse factoring method, it means they will not make the business liable for any invoices that are ultimately uncollectable due to financial problems with the invoice customer.
With non-recourse factoring, the invoice factoring company must complete a more extensive credit check on the business’s customers who have outstanding invoices to ensure the customers are excellent credit risks. While invoice customer credit worthiness is always important, with non-recourse factoring, the invoice factoring company is ultimately more concerned with the creditworthiness of the customers with outstanding invoices than it is using recourse factoring. With non-recourse factoring, due to the greater risk assumed by the invoice factoring company, factoring fees can expected to be higher.
Which to Choose: Recourse Factoring or Non-Recourse Factoring?
There are pros and cons to both recourse factoring and non-recourse factoring in terms of the risks involved. In general, if a business has credit-worthy customers, the risks are minimal for either option. The most common choice for large businesses is non-recourse factoring – – but that does not mean this choice is the best for all businesses. Because non-recourse factoring is often selected over recourse factoring, it is often the method most widely advertised by invoice factoring companies. The bottom line is that every business is unique as far as their customers who have outstanding invoices. The best thing to do is sit down with a representative from a reputable invoice factoring company and discuss the terms and conditions of both recourse and non-recourse factoring agreements. After a thorough discussion, it should become clear as to which choice should be selected.
Editor’s Note: Greg Curtiss is President of The Invoice Bankers. Mr. Curtiss previously was a lawyer and has passed the CPA exam. He has been in business for over 25 years. You can reach him by calling 303-740-7600 or 1-888-740-1750.