Invoice Factoring – Sellers Liability
Invoice factoring is a simple and efficient way to release the cash in your unpaid invoices by giving you access to working capital that lets you grow your business. Like all financial transactions, there are some drawbacks. One of the most important things to be aware of here is the legal obligation on you as the business owner if the debtor does not pay the invoice. Essentially there are two types of invoice factoring, recourse, and non-recourse invoice factoring. Let’s examine those in more detail.
Recourse factoring and non-recourse factoring
With recourse factoring, the factor, ‘buys’ your invoice and gives you an advance payment against it. The advance is at a discounted amount of the face value of the invoice. If your customer does not pay the factor within a set time period, usually 90 days the factor will recourse the invoice. If the debtor defaults on payment, you have a legal obligation to buy the invoice back from the factor. This is usually done by recovering the amount from future invoices.
In a non-recourse factoring agreement, the factor does not ask the business owner to buy back the invoice in the event of debtor non-payment. Any losses, unpaid invoices or late fees are absorbed by the factor. absorbed by the factor, leaving the business owner whole. This type of factoring is more risky for the factor and is priced accordingly.
On the face of it, non-recourse factoring looks as though it may be the better option for the business selling the invoice to the factor.
Both types of factoring have advantage and disadvantages. Recourse factoring comes with a lower transaction cost but as already identified the business owner is responsible if the customers default on payment. On the other hand, non-recourse factoring offers a risk-free transaction for the business owner but often carries a higher transaction cost.
Before deciding which type of factoring to take up a business owner should carefully asses their debtor’s ledger and the value of their invoices. If the overall invoice amount is small, the business owner may decide that the company can absorb the risk that comes with recourse factoring.