What Is Non-Recourse Factoring?
Non-recourse factoring is a popular factoring facility, where the factoring company has to assume the risk of credits if your customers are not able to pay for their invoices because of insolvency within the factoring period. This means, the factoring company helps in insuring the account receivables of the business. However, these factoring contracts are more expensive in comparison to other forms of factoring, as here the factor will have no recourse or chargeback against the unpaid invoices.
How does Non-Recourse Factoring Work?
Like most of the factoring transactions, the invoice is purchased in two installments. The first installment, also known as advance covers about 80% of the total value of the invoices and gets deposited into the account after the invoices are factored. The rebate or final installment covers the rest 20% and this settles your transaction.
In non-recourse factoring you can take advantage of payment protection only for the first installment. In case of non-payment, the business does not have to refund the advance to the factor. You get to keep the funds, while factoring company bears the loss. But, as the invoices are never paid by your customers, the second installment isn't provided as well.
An important thing that should be noted is: non-recourse factoring does not provide any sort of protection against service or product dispute, payment disputes or late payment disputes. For instance, a typical non-recourse factoring program will not secure your invoices when:
- The customer is not satisfied with the quality of work or product and thus withholds payment
- The customer has a dispute in terms of the amount of invoice and reduces the pays
- The customer brings changes to payment terms or delays payment
- The customer decides that it does not want to pay (other than credit issues or insolvency)
What Types of Business Should Consider Nonrecourse Factoring?
Companies that are of any size that perform business-to-business transactions or wish to secure liquidity should enhance their management of account receivables and protect their company against the risk of insolvency. In addition, the help of a factor would be beneficial for businesses that don't have the required money, resources or time for taking the responsibility of invoice payments.
Therefore, non-recourse factoring is the ultimate option for businesses that require influx of high cash flow for sustaining their operations. Though the costs might be on the higher side, you will never have to worry about buying the invoices back from the factoring firm when they are not covered, so the advance upfront payment that your business receives for invoices stands 100% credit-risk free.
The Advantages and Disadvantages of Nonrecourse Factoring
There are a number of reasons that make non-recourse factoring an appealing choice for business and these include:
- Enhances Cash Flow: A major and obvious benefit of non-recourse factoring is that it would improve the cash flow significantly. By financing the slow paying invoices you get to boost working capital in no time.
- Bad Debt Protection: As per the non-recourse plans you will never have to experience the risk of a bad debt, even when the customers do not pay back. Instead, the risk is completely transferred to the third party (factoring company).
- Flexibility of Choosing Invoices: In this factoring, you can choose the invoices that will be factored. This indeed offers a great advantage, because each business has its own set of financial needs. Some would want to factor their invoices more often compared to others.
Besides the benefits, there can be certain disadvantages to non-recourse factoring and some of them are:
- Conservative Credit Limits: A non-recourse account comes with strict credit limits for the debtors. This potentially limits your sales to specific accounts and this limits your access to the working capital.
- High Factor Fees: As mentioned earlier, the factor fees of non-recourse program is higher that its counterparts. Apart from this, the factoring company also stipulates a monthly minimum fees or invoice volume commitments.
In the end, non recourse factoring is all about transforming of value (the invoices) into much-needed cash. Every factoring agreement may not be the same, so it's crucial to consider the contract and ask any queries that you have in order to make the most of it.