Over a year ago the world factoring total stood at well over 2 trillion dollars. While businesses seem to be familiarizing themselves with the advantages of factoring as a whole, there are still a number of questions that go unasked. Certain problems will arise and relationships become strained when we don’t have all the facts prior to establishing a business relationship.
When businesses set out to factor invoices they are concerned about many things; the availability of funds, the strength and reputation of their factoring company, even the fees associated with factoring. There is one specific question that should be on the minds of all potential borrowers and that is question is what happens when one of your customers can’t pay on an invoice you’ve sold to a factoring company? The answer to this question is largely dependent on which type of factoring facility you have in place.
Ask the Question
Is your factoring facility a recourse or non-recourse finance facility? This answer will affect the fees you are expected to pay, potential for “charge back” as well as the future relationship with that factoring company.
A recourse factoring company has been referred to as a discount factoring company simply because the Client assumes the risk of repayment of an invoice instead of the factoring company. This means that even though your factor has purchased your invoices, and given you an advance, they still have “recourse” at some point should they not be able collect from your customers. For the client; however, this could mean lower fees, a loan that is easier to obtain, and the possibility of less stringent rules regarding business requirements.
An added bonus in recourse factoring is that during the underwriting process, recourse factoring tends to provide in-depth customer screening during the underwriting process which could reveal past payment experiences, high balance information, and other issues that would deter an invoice from being paid. Because of this in-depth screening process you should be aware that not all of your customers will be deemed acceptable to factor. Because recourse factoring offers a factor the least amount of risk, it is the most affordable option for a business seeking to factor invoices in order to increase cash flow.
Simplified, if your customer does not pay an invoice after a specified amount of time (typically 75 to 90 days), you will be responsible to buy back your invoice from the factoring company. This process is sometimes referred as “charge back” but could potentially be offset against other credit worthy invoices if you have been factoring on a regular basis.
The alternative to recourse factoring is non-recourse factoring. This type of factoring is typically referred to as traditional factoring and has a long-standing reputation for having its own protections built in for the factor. It is also known for having higher fees associated with its terms.
In most instances, non-recourse factoring assumes all responsibility for non-payment and in turn the Client pays a higher price to avoid chargebacks on unpaid invoices. You should also be aware of certain clauses in your agreement which could allow for adjustments to your relationship if an invoice is not paid by one of your customers.
In this type of factoring, if one of your customers does not pay an invoice per the terms listed, you do not have to buy back the invoice; however, due to the additional risk by the factoring company, the fees associated with factoring will generally be higher and if there is a dispute by the customer (i.e. wrong product, size, or color), the invoice will eventually be charged back in a similar recourse fashion.
Does It Matter?
The bottom line? Always ask questions. A company who is unwilling or unable to provide clarity regarding pricing upfront is probably not the factoring company you are looking to work with. Do your own research in order to determine which program is best for you and your business while keeping in mind the difference of the two options and how that will affect your business and its financial future.