Availing factoring service is important for any business as it allows them to focus on core business activities rather than collecting money from its customers while also easing out the working capital crunch. This article throws light on factoring and understanding the difference between the two before deciding which one to avail.
Invoice factoring is an invoice financing method a company can obtain funds by selling its unpaid invoices to a financing company at a discounted price. The financial institution will release 80-90% of the funds immediately. When the customer makes the total payment to the financial institution, it will deduct its fees and final payment to the supplier.
Companies usually opt for factoring to meet their working capital requirements. Factoring is of two types: recourse or non-recourse.
Both of these methods help the business to run smoothly. But, deciding on which type of factoring to avail depends on the needs and working capital requirements of the business and the creditworthiness of its customers.
Recourse invoice factoring is when the financial institution lends money by keeping the unpaid accounts receivable as collateral. This type of factoring requires a personal guarantee of the management of the company that it will buy back any non-performing accounts receivable kept as collateral. This means the company is still responsible if the invoices are not paid on the due dates. The financial institution charges less fees and offers higher advances under this factoring method.
Under non-recourse factoring, the financing company bears the credit risk liability. In case of non-payment of a factored invoice, the financing company cannot ask the supplier to buy back its factored accounts receivable. The financial institution charges more fees and offers lesser advances than recourse factoring.
Here, the financing company is taking more risk, so to avail these services, the supplier must have a strong history of prompt on-time payments. Availing funds through this method is favourable if you are risk-averse.
|Recourse Factoring||Non-recourse Factoring|
|The supplier's credit risk.||The financing company bears the credit risk in case of non-payment by customers.|
|The supplier buys back the unpaid invoices from the financing company.||The financing company bears the obligation of unpaid invoices.|
|It is favourable for businesses where instances of bad debts are low.||It is favourable for businesses with high bad debts.|
|The factoring fee is lower when compared to non-recourse factoring.||The factoring fee is generally higher as it involves risk.|