Recourse and Non-Recourse Factoring
Do you know what type of Invoice Factoring solution is best for your business?
Simply put, there are two forms of Invoice Factoring you absolutely need to know about: Recourse Factoring and Non-Recourse Factoring.
Why are they so important?
Because if you are informed and aware of these types of Invoice Factoring, you will also gain the ability to choose the best option to save time and money for your business.
Now that I’ve got your attention, let’s find out more about Recourse and Non-Recourse Factoring.
By the end, all of your questions about Recourse and Non-Recourse Factoring will be answered, including how they work and which is best for your business.
So, you’ve entered into an Invoice Factoring agreement with a great provider and just received access to working capital from the sale of your invoice. Initially, you decide on Recourse Factoring because it seems like the less expensive option.
Suddenly, you have the option to switch to Non-Recourse Factoring (otherwise known as Bad Debt Protection) to protect your finances, but at an additional cost.
What do you do?
First off, the primary difference between Recourse and Non-Recourse Factoring comes down to what happens in the event of non-payment from your customers due to credit reason, such as insolvency.
Recourse Factoring gives your provider the legal right to demand payment of the unsettled invoice from you. Non-Recourse Factoring means your provider bears up to 100% of the credit risk, handles insolvency, and settlement.
Admittedly, Recourse Factoring tends to be favored by both providers and businesses with creditworthy customers, because it is the easiest and cheapest form of Invoice Factoring.
However, Non-Recourse Factoring has been steadily gaining traction as more businesses become aware of the negative impacts associated with bad debt. In fact, the UK Asset Based Finance Association reported an 11% increase in Non-Recourse Factoring between June 2016 and June 2017.
Here’s the point: By understanding both types of Invoice Factoring, you will save time and money when you recognize which is more suitable for your business.
What is Bad Debt?
If you want to know more about Recourse and Non-Recourse Factoring, you need to understand their fundamental component: Bad Debt.
Specifically, the debt from your customers that is no longer collectible due to their insolvency or another credit reason for non-payment.
Bad Debt occurs more frequently in B2B companies because they generally make sales on credit terms, which generates a higher volume of sales and grows their businesses. Therefore, B2B companies are subject to more risk of customers becoming unable to settle their invoices, due to their business circumstances changing.
When you choose to use an Invoice Factoring solution, you sell your invoices at a discount to a provider who gives you an immediate cash injection based on the value of your invoices. In the event of Bad Debt, your provider will either collect payment from you or take on the risk themselves.
Invoice Factoring providers credit check your customers in order to make sure they have a history of repayment and no bad debt. They also offer up to 100% Bad Debt Protection on your invoices, although this depends on the provider and the creditworthiness of your customers.
Now that you know what Bad Debt is, let’s move on to Recourse Factoring and Non-Recourse Factoring.
To begin with, Recourse Factoring gives providers the legal right to collect payment from you in the event that your customer is unable to settle their invoice due to credit reasons such as insolvency.
Essentially, you are buying the invoice back from the provider, and will be expected to settle the full invoice amount plus interest charges and service fees from the money lent.
Recourse Factoring does not offer Bad Debt Protection.
You are taking on the risk of customer non-payment. This means you need to be sure that you have stable, creditworthy customers or your business is large enough to comfortably return the funds from the bad debt.
In general, Recourse Factoring terms also set a time limit of up to 120 days for you to settle the invoice plus interest charges and fees. This is a serious problem if you have already spent the funds that were advanced, and may cause unnecessary damage to your business.
Providers and businesses tend to prefer Recourse Factoring because it has lower fees and easier to operate, as opposed to Non-Recourse Factoring. However, Recourse Factoring could end up costing you much more if one of your customers becomes insolvent and cannot settle their invoice. Therefore, carefully consider if you are prepared to take on the risks associated with Recourse Factoring.
On the other hand, Non-Recourse Factoring means that the majority – or all – of the credit risk is transferred to your provider. You receive Bad Debt Protection on an agreed-upon percentage of your invoices, which means that you are only liable for a small portion of the invoice in the event your customer cannot settle their invoice.
Your cash flow automatically becomes more secure, and you are able to run your business without worrying about invoice settlement and collections. Although, you’ll still be required to pay the interest charge and service fees on the amount lent.
The provider has the right to take legal action against your customer and handles the insolvency process. This is due to the fact that they bought your invoices, which gives them ownership and liability over them.
Additionally, providers also perform thorough credit checks on your customers to determine whether Bad Debt Protection can be offered. Following this, you’ll be able to choose which invoices to cover such as those to new, riskier customers or that are high-value.
As a result of this additional level of service, Non-Recourse Factoring is has higher costs than Recourse Factoring. However, it undeniably saves money and protects your business in the event of customer insolvency, as you are not responsible for settling the invoice on their behalf.
Note: some providers offer Non-Recourse Factoring, but their contracts will list various reasons as to why an invoice is exempt from Non-Recourse. Therefore, carefully read the terms of your Non-Recourse agreement to ensure there are no unfortunate surprises down the road.
Comparing Recourse and Non-Recourse Factoring
Seeing as you understand what Recourse Factoring and Non-Recourse Factoring are, the next step is to compare them.
What are their advantages? Disadvantages? Similarities? Differences?
You will find the answers to these questions in the following comparison table:
|Recourse Factoring||Non-Recourse Factoring|
There are both advantages and disadvantages to Recourse and Non-Recourse Factoring, which depend on the risk of non-payment.
Clearly, Recourse Factoring allows you to save on costs and obtain more net funds from your invoices, but only in the case that you don’t incur Bad Debt from your customers.
On the other hand, Non-Recourse Factoring gives you more peace of mind because you know that your finances are secure. You are able to use the advanced funds to grow your business and make new investments.
However, Non-Recourse Factoring is more expensive to maintain as part of your ongoing Invoice Finance facility.
This brings us to the next section, which will help you figure out whether you should use Recourse Factoring or Non-Recourse Factoring.
Should You Use Recourse or Non-Recourse Factoring?
- Have experience with Bad Debt?
- Want to protect yourself from potential credit risks?
- Have a small number of customers that make up the majority of your sales?
If you answered “yes” to any of the above questions, then you should definitely consider Non-Recourse Factoring.
Non-Recourse Factoring is a low-risk Invoice Factoring solution for your business. It transfers the burden of credit risk onto your provider, and allows you to protect your finances.
For example, if you have a small number of customers that make up the majority of your sales, you could face an overwhelming invoice repayment and lose out on a large amount of working capital. But with Non-Recourse Factoring, you don’t have to repay the invoice to your provider, and you get to continue using the advanced working capital.
Non-Recourse Factoring is suitable for businesses of all sizes. Small businesses need the additional security of Non-Recourse Factoring to protect their finances in order to grow. Also, they don’t usually have the resources to sufficiently recover from the losses from Bad Debt.
Meanwhile, larger businesses should also consider Non-Recourse Factoring because it actually takes a lot of resources and effort to recover from even a small amount of Bad Debt.
For instance, a business with a turnover of £1.5 million and a 5% margin would need to increases its turnover by 30% in order to compensate a Bad Debt worth only £22,500.
Let’s talk about Recourse Factoring.
Yes, Recourse Factoring does mean that you take on the credit risk of your customers, but there are certain cases where it is a better solution than Non-Recourse Factoring.
- Have stable, creditworthy customers with histories of on-time payments and no Bad Debt?
- Spread out your invoices over a large customer base?
- Believe that your business would not benefit from the additional security of Non-Recourse Factoring?
If you confidently answered “yes” to the above questions, then Recourse Factoring is a suitable Invoice Factoring solution for your business. You’ll be able to save on extra costs, while having immediate access to necessary working capital to grow your business.
At this point, you should be much more confident to answer the question posed at the beginning of this article:
“Are you sure you know what type of Invoice Factoring solution is best for your business?”
You know what Bad Debt is, how Recourse and Non-Recourse Factoring works, as well as their advantages and disadvantages. You have also considered your business needs and willingness to take on the credit risk, and have a better idea as to whether your business is more suitable for Recourse Factoring or Non-Recourse Factoring.
Well done! You’ve made it through to the end of this guide to Recourse and Non-Recourse Factoring. So go ahead and use your newly-acquired expertise to choose the best Invoice Factoring solution for you.