There are multiple benefits to factoring your invoices, most important being that factoring helps you increase your cash flow for things like payroll, operating expenses, taking on new business and more. Additionally, a factoring company will provide back-office support by managing your collections on any invoices you've submitted for factoring. But what happens if a customer's client (called a debtor) does not pay one of those invoices? The outcome of this situation will depend on the type of factoring agreement you have with the factoring company.
Two Types of Factoring
There are two main types of factoring - recourse and non-recourse. Recourse factoring is the most common and means that your company must buy back any invoices that the factoring company is unable to collect payment on. You are ultimately responsible for any non-payment.
Non-recourse factoring means the factoring company assumes most of the risk of non-payment by your customers. Non-recourse does not necessarily protect your company from all risk, though. There are usually stipulations associated with non-recourse factoring, and the situations in which you are not responsible for customer non-payment are very specific.
For example, many factoring companies offer non-recourse that only applies if a debtor declares bankruptcy. And they will limit non-recourse agreements to debtors that have a good credit rating, meaning the debtors bad credits ratings (who are at the highest risk of non-payment) aren't even eligible for non-recourse. Because non-recourse agreements typically have a higher factoring rate (sometimes by a full percentage), it's important to determine whether the higher rate is really worth the cost.
Understanding Terms
Whether your company plans to pursue recourse or non-recourse factoring, it is important to sit down with a reputable factoring company to discuss their terms. It may be to your advantage to find a factor that offers both recourse and non-recourse factoring. A factoring company with a strong credit team can also help you avoid working with customers that have poor payment histories.
Regardless of the type of account, a good factor will always make a diligent effort to collect on your invoices. Collection calls from the factor to a debtor should start 40 days after the invoice was sent and continue for several weeks. After 90 days, the factor may “recourse” the invoice back to you. The factor should, however, provide options for helping you cover the cost. The factor may withhold a portion of future cash advances or deduct cash from your reserve account. Working out an unpaid invoice should not cause your company financial hardship, as it isn't in the best interest for you or your factor.
The best option is for your company to have customers with good credit and solid payment histories. This enables you to pay lower fees for recourse factoring without worrying about the risk.
Still have questions about recourse versus non-recourse factoring? Reach out to RTS Financial today!