Companies facing a cash shortage problem often consider various ways of solving the problem. Some companies sell part of the business to investors or distribute their stock. These options enable the company to obtain funds to finance its operations without the need to pay it back. In addition, it lessens the current owners’ influence since the new owners take part in making decisions for the Company. Other companies opt to take loans from banks or issue bonds. This action obliges the company to pay back the cash with the relevant interest payments. However, some companies utilize the resources they have and leverage their accounts receivable.

Accounts Receivable

Accounts receivable stands for the amount of money which customers owe a company from previous delivery of services or products. The company is entitled to ask for payments for the accounts in the normal course of business. These accounts receivable often arise when companies give their customers 30 or 60 days allowance to pay for goods or services delivered.

Why Factor?

Factoring occurs when a company sells its receivable accounts to another company in exchange for cash in advance of the accounts receivable due date. The company pledges its rights to collect its receivable accounts to the factoring company. Companies decide to factor their accounts receivable for several reasons. Some companies are looking for cash to pay pressing financial obligations, especially when subjected to an unexpected increase in sales or when accounts payable become due faster than the payment terms of payment under the accounts receivable.

Other companies choose to concentrate on their business plan instead of focusing on the collecting their accounts receivable. Companies that decide not to collect their own accounts receivable can factor their accounts receivable.

Factoring With Recourse

A company that factors with recourse is one that works with a factor who lends against the accounts receivable using them as collateral to advance funds.  Typically recourse factoring requires the personal guarantee of management or the owners because the owners must maintain liquidity to purchase back non-performing accounts receivable taken as collateral by the factor.

Factoring Without Recourse

Any factor that gets into a purchase agreement with a company without asking the company to repurchase unpaid accounts is automatically a non-recourse factor. The factor assumes the credit risk of the company’s customer.  The company has no liability to the factor once the factor purchases the account from the company. Factors often are compensated differently for taking the credit risk away from the company.

Two Ways to Factor

Recourse factoring is a more common method of factoring and comprises a bigger part of the accounts receivable financing industry. Remember, recourse is an agreement between you and the factor to purchase back any non-performing accounts receivable as you have taken the credit risk. The agreement enables your company to buy back receivables that the factors deem non-performing in this arrangement, the client covers the cost of invoices that your customers does not pay.

Non-recourse factoring is the best choice especially if you are in a risk-averse. However, it is important to know that not all factoring companies purchase accounts receivable on a non-recourse basis. Companies that do not offer non-recourse factoring normally include various stipulations.

It is imperative to know the difference between the two types of factoring before making a decision on how to fund your company’s working capital needs. As a businessperson, you can get quick access to cash by factoring your invoices. In simple terms, factoring is the selling of company account receivables to a factoring company in exchange for an immediate cash advance.

The factoring companies are reimbursed for their cash advance to you when the debtors settle their accounts with the factorThe factor requires their customers to pay transaction fees or commissions regardless of whether all pending invoice payments have been made.

Understanding the Terms

When looking for a factoring company, it is important to research several competent factoring firms and compare their terms. This is an important step to take regardless of whether you are looking for recourse or non-recourse factoring. Consider working with a factor that provides both types of factoring. Some of your clients may make better candidates for recourse factoring than others.

Factors with a competent credit team can help your business deal with customers with poor payment histories. A good factoring company can help you make significant reductions in your losses due to non-payment by assisting you in analyzing the credit of your customers before you start the work or deliver goods.

How to Use Factoring for cash flow

Recourse Factoring involves pledging a company’s invoices in exchange for an immediate cash advance.  Any non-performing accounts receivable must be paid off by the company or the owners should the factor request payment of the non-performing accounts.

Nearly all factors are recourse to avoid the risk of unpaid accounts. Recourse factoring has several advantages for lenders. Lenders in this arrangement face minimal risks. The factor does not have to deal with risks of non-performing accounts receivable.

Many lenders find recourse factoring more advantageous because the owners have provided them with a guarantee of payment when an accounts receivable becomes non-performing. On the other hand, the borrower faces greater risks because they are responsible for all uncollected payments.

Clients often find non-recourse factoring beneficial. However, this type of factoring requires the factoring company to absorb all the debts or uncollected invoices.   It is less risky for management because if they provide the service properly or deliver the product as agreed they do not have to repay the factor for non-performing accounts receivable like they would under a recourse factoring agreement.

Which Type of Factoring is Suitable for my Business?

There are advantages and disadvantages of both recourse and non-recourse factoring. In general, businesses with creditworthy customers face less risk regardless of whether they choose recourse or non-recourse factoring. Although large businesses often prefer to choose non-recourse factoring, this choice is not always the best for all types of businesses. Every business is unique as far as dealing with customers with outstanding invoices is concerned. It is important to consider the benefits and drawbacks of both recourse and non-recourse factoring. This should help you decide the type of factoring that is good for your business.