When it comes to factoring there are a lot of different aspects that need to be looked at when determining the best factoring option for your business, however, the decision between recourse and non-recourse is probably the most important. Quite simply, recourse means that if a customer does not pay an invoice, then you are responsible for paying back the advance you received on that invoice. Non-recourse on the other hand means that you are insured against a customer who doesn’t pay for an invoice, so there is no need to pay back the factoring company if they don’t pay. While this may seem like a simple difference, there is actually a lot more to it than what these simple descriptions state.
With recourse factoring you are receiving an advance on your invoices, but your factoring company is not purchasing your receivables, they are simply offering you an advance. While your factoring company will try to collect on your invoice on your behalf, ultimately you are responsible for paying back your factor if one of your customers does not pay for an invoice that you received an advance on. Of course, you won’t be asked to pay back this advance on the day that the invoice is due. While the exact amount of time may vary between different factoring companies, typically you’ll be asked to pay back your factor once an invoice becomes 90 days beyond terms. Some factoring companies may demand the entire value of the advance at that time, while others may be willing to work with you to set up a repayment plan. The terms of repayment are something that you would have to discuss with your factoring company.
With non-recourse factoring your factoring company isn’t just providing you with an advance, but they are actually purchasing your invoices from you along with all the associated risks. Non-recourse factoring is much more than just receiving credit insurance with an advance, because with non-recourse factoring there is no need to file claims, there are no minimums or deductibles that need to be met, and there are no premiums to pay. It is important to note that non-recourse factoring covers you only in situations where a customer is unable to pay, and it is important to understand which situations your factoring will cover. All factoring companies will cover you in the event that a customer files bankruptcy or goes out of business, although not all factoring companies will cover you in the event that a customer is simply a deadbeat. What isn’t covered is customer satisfaction, for example, if a customer takes a deduction because a product arrives damaged, it is still your responsibility to take care of it, whether that is providing a replacement or offering a credit. In general, factoring companies will hold back funds in reserve that are intended to cover them in the event that a deduction is taken. The amount of reserve taken depends on the factoring company but typically falls between 10-20%. Once a factoring company receives payment for an invoice, they will return any funds held in reserve to you. It is important to note that even with recourse factoring, your factoring company will still hold 10-20% in reserve.
While it is clear that non-recourse factoring offers benefits that recourse factoring does not, there of course is more that goes in to the decision between recourse vs non-recourse. You also need to consider cost, approval rates, collection efforts, credit limits, and debt.
Some factoring companies may offer you an option between recourse and non-recourse factoring, and in this case they may offer a lower rate for factoring with recourse. Other factoring companies will only offer one option. However, just because one factoring company may offer a lower rate for recourse factoring, that doesn’t mean that it is necessarily the best rate. There is a lot that goes into a factoring rate, and recourse vs non-recourse is just a small part of it.
Besides differences in the rates of factoring, there are other costs that you need to consider. With non-recourse factoring there is no need to purchase credit insurance, however, you may wish to purchase credit insurance if you are using recourse factoring. In this case, you need to consider the cost of premiums as well as minimums and deductibles. It is also important to note, even I you file a claim at the same time that your factoring company asks you to return an advance you received, it could take anywhere between 30-90 days to receive payment from your insurance company.
Should you choose to forgo credit insurance, then it is important to consider what your losses may be. This is a little bit more difficult to calculate and these numbers can fluctuate wildly between any given year, and it can be very difficult to predict when the next economic turndown will take place which could lead to higher losses than expected. In general, to figure out these costs, you probably will need to look at a decade’s worth of data, and even that won’t prepare you for extreme events such as the COVID-19 pandemic.
Another thing that some factoring companies promise is a higher approval rate with recourse factoring, although this can be difficult to substantiate and actually may not be beneficial at all. Performing credit approvals is a very important aspect of factoring and one of its primary benefits. Your factoring company will check out the credit worthiness of your customer before you produce an order to ensure that your customer ultimately has the means to pay you for it.
With larger invoices, for example an invoice for $100,000, there will be little difference in the credit approval process between recourse and non-recourse factoring. Both types of factoring companies will do a deep analysis of the customer to ensure that they are credit worthy. In the case of the non-recourse factoring company, they will ultimately be out the money if a customer is unable to pay. However, the same is true of the recourse factoring company as most likely you will not have $100,000 available to pay them back in the event that a customer does not pay. So in all likelihood, there is very little difference in the approval rate of large orders between recourse and non-recourse factoring.
Where you may see a difference in approval rates is with smaller orders. An order for $250 may receive two very different approaches. A recourse factoring company may not even bother to credit check the customer and may just automatically approve your order. To them, if the customer is unable to pay, they know that you will be able to afford to pay them back the $250. So while they are giving you a credit approval, they are actually doing you a disservice as they may be sticking you with bad debt. A non-recourse factoring will run the appropriate credit checks knowing that they will be out $250 if the customer is unable to pay. That doesn’t mean that the non-recourse factoring company is unlikely to approve them, most factoring companies are willing to extend a small line of credit to new businesses or businesses that haven’t established any credit yet. However, if a factoring company is willing to give a small line of credit to a company that is trying to establish credit, they are assuming all the risk associated with doing so.
One of the main benefits of factoring is that your factoring company handles all of the collections for you. However, just like with credit approvals, recourse and non-recourse factors may take different approaches when it comes to collecting. For a large order there is little doubt that a recourse factoring company will try their hardest to collect it, knowing that if they can’t collect it will be very difficult for you to pay them back. It is the small orders that are more problematic. If a factoring company is having a difficult time collecting a several hundred dollar invoice, they may give up if they feel it would be easier just to collect the amount from you. The same can not be said of a non-recourse factoring company. Since they are on the hook for the invoice, they will work their hardest to collect even on the smallest of invoices. Of course, whether or not your factoring company is able to collect, you have nothing to worry about as you are fully insured.
There really shouldn’t be any difference in the credit limits assigned to your individual accounts by either recourse or non-recourse factoring. Assuming that they are credit checking the customer, their credit limits should be consistent. However, if a recourse factoring company isn’t really checking out your accounts in too much detail because they can charge back an invoice to you, then they may assign a higher credit limit. However, where credit limits come into play is when it comes to sending funding for you. A recourse factoring company may assign you a credit limit across all of your accounts to ensure that invoices don’t get paid, that you will have the ability to pay them back still. Presumably, most accounts are going to pay, so this credit limit should be very high, however, it could prove to be problematic if your business starts growing at a faster rate than expected or you get a very large order. On the other hand, you have no credit limit with a non-recourse factoring company. Since you have no obligation to ever pay back your factoring company, you have no debt with your factoring company. As a result, the sky is the limit when it comes to how much you can factor with non-recourse factoring.
The final major difference between recourse and non-recourse factoring is debt. One of the best features of factoring is that it is a form of debt-free financing. Certainly this is true in the case of non-recourse factoring where your factoring company is purchasing your receivables and you are under no obligation to pay them back, the receivables will be paid back by your customers. However, this isn’t entirely true with recourse factoring. While the vast majority of your customers should and will pay their bills, you are still responsible for the ones who don’t. When a customer is unable or unwilling to pay, it becomes your obligation to pay back your factoring company, meaning that you are in debt to them.
While it would be simple to say that non-recourse factoring is better than recourse factoring, it is just one of the aspects that needs to be considered in determining which factoring company is right for your business. Oftentimes the industry that you work in will determine whether or not non-recourse factoring is an option and which factoring company would be the best fit for you.
At DSA Factors we are proud to offer non-recourse factoring to all of our wholesale clients. We are a family owned business that has been factoring for over 35 years. If you have any questions about factoring, whether they pertain to non-recourse or any other aspect of factoring, please don’t hesitate to give us a call at 773-248-9000, email us at email@example.com, or chat with us right here on this web site.