A guide to recourse and non-recourse factoring
Discover the difference between recourse and non-recourse factoring, and choose the option that is best for your business
Invoice factoring can be a cash flow lifeline for many small businesses. However, it can also be a bewildering world full of jargon that can end up costing you more in the long-run.
Understanding the different types of factoring is important for making the right decision for your business. A key concept to understand is recourse factoring and non-recourse factoring.
What is recourse factoring?
Recourse factoring, or factoring with recourse, means that the factoring company retains the right to collect payment from you, if your customer doesn’t pay. There will usually be a time limit in place for this – a certain period after the invoice becomes due.
Factoring with recourse, as opposed to non-recourse factoring, is a primary way that factoring companies address their factoring risk management. Recourse factoring balances risk between the factor and client. Non-recourse factoring is when the factoring company agrees to take the risk of non-payment on themselves. This will come with a higher factoring fee, but obviously gives you some protection from non-payment.
Recourse factoring is a great cash flow solution for small businesses that need capital to ensure the smooth operation of business activities. However, you must be very careful to manage your risk effectively.
The factoring company may well advance you money for invoices but it is vital to remain aware that you are still liable to pay the factor for the invoice if your customer does not. This can pose a problem for you if you’ve already spent the cash advance sent to you by the factor in anticipation of the invoice being paid. As a result, it’s important to consider how you manage the selling of your receivables with recourse.
Find out more on out what is invoice factoring page.
How does recourse factoring work?
In recourse factoring, you are not alleviated of any bad debt. As a result, these arrangements are cheaper (have a lower factor rate) than non-recourse agreements. In the instance that your customer does not pay before the recourse date, you will be liable for the money owed to the invoice factoring company. You agree to the risk. Even if you pay quickly, you will still be charged a fee and interest.
A simple example of recourse factoring is as follows:
You decide the best option for ensuring good cash flow is selling receivables with recourse. You submit an invoice for factoring that is worth £20,000.
You receive an advance of 80% immediately, which in this case is £16,000. The invoice is due for payment by the customer within 90 days.
After 90 days plus the additional time determined in your agreement, the customer still hasn’t paid – the recourse date has been reached.
You are now liable to pay that original £16,000 to the factoring company, plus the factoring fees (let’s say, 3% at £600), plus any other charges you agreed to, and interest.
Advantages and disadvantages of recourse factoring
A factoring company is always going to take a careful approach towards their factoring risk management, and as such always try to mitigate and reduce risk. As a result, the main advantage is that this type of factoring is cheaper. The factoring company knows it has comeback should the debt prove bad. Therefore, it is more prepared to take on your receivables at a lower cost.
This also means that recourse factoring can happen faster than non-recourse factoring. The factoring company may have a lower threshold that your business and the customer need to meet. Furthermore, it may be prepared to take on an invoice that it wouldn’t be prepared to do under a non-recourse agreement.
However, you need to be aware that you will be liable for any unpaid debts. You will also need to manage how the debts are collected by the factoring company. Often, small businesses are worried that using a factor could sour relationships but the way debts are collected can be effectively managed to minimise and, in some cases, eliminate this concern.
When is recourse factoring a good option?
Recourse factoring is a good option when you need cash fast and when you know that your customers are reliable payers. If you know that your customer always, without fail, pays its invoices in good time, then you may consider the risk to be minimal. Therefore, you know that you can factor the customer’s invoice and keep your business running smoothly with the cash advances from your factor.
Recourse factoring is not a good option for customers you are unsure about, such as those that have taken their time over paying before, or if you’ve had any issues over their payments in the past. In these instances it might be better to select other invoices for factoring, or to opt for a more expensive but safer non-recourse factoring option.
Recourse factoring fees
You should bear in mind that many factoring agreements will be on a percentage rate until the invoice is paid. Therefore, this can feel a little like signing a blank cheque. To solve your cashflow problem now, you may face another down the line. On the other hand, if you are able to effectively manage your risk and finances, then recourse factoring can be an extremely rewarding and cost-effective cash flow solution.
What is non-recourse factoring?
Non-recourse factoring is when the factoring company takes on the risk of an invoice not being paid itself. It advances you the money, accepting that there is an element of risk that it may not get paid. This comes at a price. You will be charged a higher factor fee for non-recourse factoring.
Bear in mind that non-recourse factoring is not a black or white option. It can be more of a sliding scale, so check the conditions carefully. Sometimes you will be expected to pay a flat-fee or even discover that recourse is possible under certain circumstances.
As a word of warning: check the terms and conditions of your factoring agreement carefully. Even if a factoring agreement is called non-recourse factoring, there may be smaller terms and conditions that act as ‘get out clauses’, limiting the circumstances in which there will be no comeback on you for an invoice unpaid.
How does non-recourse factoring work?
There are a variety of non-recourse factoring agreements, so how they work also varies. However, generally speaking you will pay a higher factor rate to compensate the risk the factoring company is taking.
You will receive the advance as with recourse factoring, but should the customer fail to pay the invoice, you will not be liable for paying that back to the factoring company. You won’t, however, see the outstanding amount either.
Let’s look at our earlier example again, this time with non-recourse factoring.
You again decide the best option for managing your cashflow is selling receivables. This time you want to mitigate against any risk of non-payment so opt for a non-recourse agreement.
This has a higher factor rate of 4% (in our previous example it was 3%). You submit an invoice for factoring that is worth £20,000. You receive an advance of 80% immediately, which in this case is £16,000. The invoice is due for payment by the customer within 90 days. After 90 days plus the additional time determined in your agreement, the customer still hasn’t paid – the recourse date has been reached.
You do not have to repay the original £16,000 to the factoring company. However, you will be liable for paying the 4% fee which is £800. You may also be liable for paying interest, and you won’t see the rest of the outstanding £20,000.
Advantages and disadvantages of non-recourse factoring
Non-recourse factoring is a way of improving your cash flow, while minimising the risk of a customer not paying. The main advantages of non-recourse factoring are that you will be able to improve your cash flow while reducing the risk of non, or late, payment. Accepting that the fees will be more than recourse factoring, there is only usually around 1% difference between recourse and non-recourse rates.
Factoring, including non-recourse factoring, also has the advantage that it can be easier to get than a bank loan, certainly faster, and is definitely more flexible than a business overdraft. One of the primary aims of factoring is speed. Generally, recourse factoring can be expected to be slightly faster than non-recourse.
Non-recourse factoring companies often have a higher threshold for checking out both you and the customer before taking on any invoices. Nevertheless, non-recourse factoring can still provide a time-effective solution to improving your cashflow quickly. You get an advance of the bulk of your invoice, even if you have a late paying customer.
There are also some disadvantages to non-recourse factoring, with two primary ones:
Firstly, not all factoring companies offer non-recourse factoring. You may not be able to get it as an option on your chosen invoice.
Secondly, non-recourse factoring rarely exists without any comeback on you at all. There are, effectively, only different levels of recourse. You need to take a fine tooth comb to the factoring agreement to see what level of recourse applies in your case.
There is also the disadvantage that non-recourse factoring will cost you more than recourse factoring. For non-recourse factoring the upfront fees will be more, but the bad debt risk isn’t yours. It’s a balance of factoring risk management. For the higher costs you pass over responsibility for chasing the bad debt. Find out more about prices and charges on our invoice factoring costs page.
When is non-recourse factoring a good option?
Non-recourse factoring can be a good option when you need help with your cash flow quickly, but you know that things will improve in the medium term. It is also worthwhile if you know that a certain customer can be tricky when it comes to paying.
Non-recourse factoring isn’t a great idea if you have reliable or suitable invoices that you could recourse factor instead. Generally speaking it is best to factor the more reliable invoices in preference to the riskier ones. It would also be somewhat foolish to opt for non-recourse factoring with a client who has always paid on time, every time, for years. You will waste money on higher factoring fees.
Non-recourse factoring fees
As mentioned previously, the fees will be more than those associated with recourse factoring due to the extra risk taken on by the factor. In order to mitigate this risk the fees are higher. There is usually around 1% difference between recourse and non-recourse rates.
Compare recourse and non-recourse factoring quotes
The information on this page should help you to understand more about recourse and non-recourse factoring. For details specific to your business though, you should speak to experts today – we can help here.
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