There are typically two types of programs offered by a factoring company: recourse and non-recourse. The primary difference is the party that is responsible for repayment of the invoice if the customer is unable to pay it within the pre-established number of days.
If a company sells their invoices to a factoring company with recourse, they are responsible for the repayment of the invoices if not paid within a certain number of days. If the customer does not make payment on the invoice, the factoring company could force the company to buy back the unpaid invoices.
As the customer is maintaining a certain degree of the risk, invoices sold with recourse generally have more flexibility, lower fees, and a higher advance fee.
A company that sells their invoices without recourse (non-recourse) passes the risk of non-payment to the factoring company. For instance, if a company’s customers cannot pay their invoices, the factoring company cannot force the company to buy back the unpaid invoices.
Non-recourse might be a good option for businesses that have customers that struggle to pay their invoices. However , factoring companies charge higher fees and provide a lower advance payment for non-recourse invoices for assuming the additional credit risk.
Some factoring companies will charge a credit protection fee to offset the additional risk for high-risk invoices. The fees vary by company but rarely exceed 2 percent.
Invoice Factoring Example
ABC Co. had a £100,000 invoice that they wanted to finance. Based on the customer’s creditworthiness, industry, and the amount of the invoice, ABC Co. secured the following terms from the factoring company:
- Advance rate: 80%
- Fees: 2% per 30 days
ABC Co. submitted the €100,000 invoice to the factoring company and received an advance payment of £80,000 (£100,000 x 80%). After 30 days, ABC. Co.’s customer paid the £100,000 invoice. The factoring company processes the payment and settles the account as follows:
£20,000 (£100,000 x 20%)
<2,000> Less factoring fee: (£100,000 x 2%)
The £18,000 payment is deposited in ABC Co.’s bank account.