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Recourse Factoring Explained

Recourse Factoring Explained

In the world of business, especially small, medium or burgeoning businesses, there are few things more important than cash equity.  Cash equity is the reason many businesses can continue to operate even during an economic downturn, and includes things like office and business equipment, cash reserves, lines of credit and even invoices.  Yes, believe it or not, invoices are an important part of a company’s cash equity, but when these invoices remain unpaid, the only way for many businesses to turn them into working cash or operating capital is through recourse factoring.  In this article we will explore the basics of recourse factoring and show you why this type of financing has become so popular among business owners.

What is Factoring?

Simply stated, factoring is a process in which a business can obtain a cash advance from a financing company based on its payable invoices.  The process works a bit like this:

  • Businesses turn payable invoices over to the factoring company
  • The factoring company holds the invoices and gives the business a cash advance based on the total cash amount of the invoices
  • When the invoices are eventually paid by the debtor (usually through the factoring company) any difference which remains between the cash advance and the money collected by the factoring company is turned over to the business.

This may sound like a sweet deal, but keep in mind that factoring companies are not doing this out of the goodness of their heart.  There is a pretty hefty fee involved which must be paid before the process even begins, and in most cases, to protect themselves from getting stuck with bad debt, most factoring companies will only issue cash advances on a “recourse factoring basis.”

What is Recourse Factoring?

There are basically two kinds of factoring:  recourse factoring and non-recourse factoring.  In recourse factoring, the process is still conducted according to the steps listed above, however there’s a catch.  If the factoring company is unable to collect on the unpaid invoices—the invoices for which a cash advance was issued against—the factoring company has the “recourse” to collect that money from the originating business.  In other words, if your customers don’t pay, you will have to cover the cost of any unpaid invoices.

Non-recourse factoring, which is not as popular due to increased liability, is when the factoring company has no choice but to collect the money due on the invoices themselves, without the added security which enables them to go after the business that issued the invoice.

Why Do Businesses Participate in Recourse Factoring?

In a perfect world, each and every customer would pay their invoices on time and in full, consistently adding to a business’ cash reserve, but in the real world this seldom happens.  Recourse factoring enables businesses to continue to operate normally as they wait for unpaid invoices to be collected on, and for this service many are willing to pay the accompanying fees to a factoring company and open themselves up for possible recourse should the invoices remain uncollected.

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