The Importance of Factoring

When small businesses face financial difficulty, their only option is to find the capital necessary to survive the situation. Traditionally, the most common way to acquire capital from a bank was to take out a small-business loan. Though this is still an option, an alternative source of funding, known as factoring, is gaining popularity.
Factoring is also known as accounts receivable financing. When clients purchase goods or services from your establishment and pay on terms, with a line of credit or a payment plan, their debt is stored in an area known as accounts receivable. Accounts receivable funding simply means that a company, known as a “factor,” is purchasing those lines of credits and payment plans from you, so you are no longer the person that the clients owe money to. This allows you to receive immediately the capital you already are owed, while the factor manages the customers and receives a percentage fee from the debt collected. There are two types of factoring, recourse, and non-recourse, and while they may seem similar, there is one major difference between the two.

Two Types of Factoring

Recourse factoring is the most common form of factoring, where the financial institution is funding your accounts receivable portfolio.The factor advances your company a designated percentage of the face value of the invoice, typically eighty percent. The invoice is then paid by the customer to the factor, and the factor pays you the 20% rebate, minus their fees. If, however, your customer does not pay the invoice after a designated period, your company must pay back the 80% advance, plus fees, and you are then responsible for collecting on the original invoice.

Non-recourse factoring works similarly to recourse, but the main difference is the major appeal of non-recourse factoring – if your customer cannot pay the invoice for any legal reason, you keep the advance, and the factor takes the loss. With non-recourse factoring, your business is almost guaranteed to collect at least 80% on all invoices. In an uncertain business climate, companies large and small declare bankruptcy all the time. Non-recourse factoring is one way to protect your company from non-payment.

Most factors offer recourse factoring, while a smaller percentage offers non-recourse. When comparing factors be sure to ask which type of factoring they have available, as only non-recourse factoring protects your business from losses.