In business it takes some time for the seller to realize the amount of the credit bills from the customers. To get immediate cash the seller business has an option to sell the accounts receivable to a third party. This process is called factoring.
What is recourse factoring? The third party who buys the accounts receivable asset is called a factor. Naturally, the factor buys the accounts receivable at a discounted price. With factoring, the ownership of the accounts receivable involved is transferred to the factor. In factoring three parties are involved. They are the seller, debtor and the factor. The seller is the one who sells goods or services and the debtor is the one who buys such goods or services on credit.
There are two types of factoring, namely, recourse factoring and non-recourse factoring. In recourse factoring the factoring firm has a right to claim the value of the invoice from the seller in case the account debtor fails to pay up. In other words, the factor has recourse to recover their money under any circumstance in recourse factoring. In non-recourse factoring the risk of non-payment by the debtor goes to the factor.
Why factoring? If the seller can get the money immediately on the accounts receivable it is advantageous to them to finance more business. When they wait for the normal 90 to 150 days for realizing the value of their bills they will be hard up for cash or they must borrow from the bank to continue business without interruption. Banks charge interest rates depending on the creditworthiness of the borrower. That is where the factoring comes in. The business can easily get finance from a factoring company. The factoring company does not look into the creditworthiness of the seller. But, of course, the creditworthiness of the debtor is looked into. That too is only in the case of non-recourse factoring.
How factoring works? Immediately on agreement on factoring a percentage of the total amount is paid to the seller by the factoring firm. This amount is called advance. On recovery of dues from the debtor the rest of the amount is paid to the seller after deducting the factoring costs and interest. The percentage to be retained by the factor as factoring cost and interest is determined in the agreement itself.
Advantages of recourse factoring On the part of the factor, there is no risk of loss due to non-recovery. The seller retains the bad debt risk in recourse factoring. For the same reason factoring at a lower rate can be offered to the sellers. The sellers can get a part of the invoices immediately and they will have a better cash flow. That will allow the business to continue without a cash crunch. There are many factoring companies. So the seller can expect very competitive rates. By factoring the seller is also outsourcing the debt recovery burden to the factoring company without any additional cost.
Now up to 80% of the bill amount is advanced by factoring companies. Both forms of factoring are great blessing for the sellers.