To those who are new to factoring accounts receivables, the terms recourse and non-recourse factoring can cause some misunderstanding. Yet once you become acquainted with the different terminology, you will find that they are fairly self-explanatory.
So let’s review the basics of invoice factoring, which involves three different parties: the business selling the current invoices for cash quickly, the client (the company that owes the money for the product or service already provided) and the factoring company itself, which purchases the invoices. Upon selling the invoices, the business collects the bulk of that cash right away. The client then is supposed to remit the bill within an agreed upon time frame, usually 30, 60 or 90 days.
Limited Recourse Financing Splits the Risk
Now let’s pause and consider what would happen if, for one reason or another, the client doesn’t pay. This is the key difference between recourse and non-recourse financing. For factoring with recourse, the less popular of the two methods, the business selling its invoices must then repurchase those same invoices. The overall financial risk is therefore reduced for the factoring company. As such, it is worth noting that recourse financing will generally cost less than non-recourse. This situation, however, leaves the business in the same financial predicament it started in: needing money fast – and now needing to chase after a client for the collection of that payment.
Most Businesses Prefer Non-Recourse Financing
Non-recourse factoring, which is also the more widely used option, means that the invoice is purchased outright. If the client does not pay, the financing company is then responsible for collecting that debt or taking a loss should it come to that. As a result, this is generally more expensive because the factoring company takes on all the risk should the client fail to pay its debt. Some financing companies only provide non-recourse while others offer a choice of both.
This overview should help those new to recourse and non-recourse factoring learn about the advantages and disadvantages between these two options. This way you can make more informed decisions on which financing option is better for your situation.