Like any type of financing, accounts receivable factoring is a risk taken by the factoring company. In most cases, accounts receivable factoring is based on the creditworthiness of the underlying customer. Therefore, a factoring company does not provide financing for invoices that are made to an individual customer, instead they provide funding against invoices made to other companies, or to government entities. This is why we need to understand non recourse factoring.
Collection Activities and B2B Transactions
Typically, when businesses are completing transactions, they offer terms that may give a company up to 90 days to make payment.
In some instances, they offer discounts if an invoice is paid sooner. In the case where a company has opted to factor their accounts receivable, they turn the risk, and collection activities over to the factoring company. However, what happens when the customer does not pay their invoice?
If a company is managing their own accounts receivable, they may put forward demand notices, and hold the company responsible for paying the invoice with certain late charges which are normally laid out in their contract. Many contracts also have a recourse clause which may hold the company owners accountable personally for unpaid bills.
If payments are not made as agreed, you would typically stop doing business with the company until the invoice was paid in full. Chances are, you would likely require a deposit or full payment before doing additional business with the company. This is known as full recourse.
Meaning of Non Recourse Factoring
But, what happens if you are working with a factor and they have offered to factor your receivables with no recourse?
First, it is important to understand what no recourse means. In most factoring contracts, no recourse usually means that the factoring company will not seek payment from you under certain conditions.
The typical condition is the insolvency of the customer that occurs during the time of the factoring period.
For example, if you have issued an invoice that is due in 90 days, and a factoring company has advanced you cash against that invoice, the company would have to go out of business during the 90 day period between issuing the invoice and having the payment due.
What Non Recourse Factoring Does Not Cover
Even if your factoring company has agreed to factor your receivables without recourse, there are certain exclusions which you should be aware of. For example, in most cases, factoring advances will not be considered without recourse if:
- There is a dispute over an invoice – if you have issued an invoice and your customer disputes the invoice, chances are, the factoring company will not allow you to walk away from the debt you incurred because of factoring.
- You deliver products to non-paying customers – if you have a customer who has been consistently late paying invoices and you are still delivering product to them, you are increasing their outstanding amount owed, meaning the factoring company is at even more risk of losing money. Most of the time, you will be held responsible for these invoices.
- You owe the company money – if you have a reciprocal arrangement with a company you do business with, and the company credits amounts you owe them against amounts they owe you, the factoring company may not grant you the ability to factor those invoices without recourse.
When entering into a factoring contract, it is important to understand the terms you are agreeing to abide by.
We make sure our contracts are easy to understand and you understand whether you are accepting funding against your receivables with or without recourse.
Capstone is a private finance company offering various solutions to businesses to provide them with more consistent cash flow.
Contact us today to request funding or to speak with one of our representatives to learn more about how Capstone can help your business grow and flourish.