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 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.
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.