When companies need access to cash in a hurry, they have but few options. They can apply for a business loan or extension on their business credit line.
However, that takes time and doesn’t guarantee results. There’s also the problem of getting refused and having it negatively impact a company’s credit rating. A bad business credit rating always comes back in the form of higher interest rates. So, if that business loan isn’t an option, what’s next?
Well, thank goodness there’s factoring. Not sure what factoring is and how it can help your business? Read on.
Factoring is not new, has been around for quite a while, is run by professional companies, and is a viable option for businesses needing to address cash flow problems.
Factoring involves a company selling its outstanding invoice to a finance company. In return, the finance company pays for a portion of the invoice’s value and proceeds to collect on the full amount. Once they receive payment for the full value of the invoice, they then provide your business the remaining portion, minus their fee.
Central to using the factoring option is to understand its two variations. There’s recourse factoring and non-recourse factoring. Both have their merits and both have their drawbacks. It is incumbent upon business owners to weigh the good and bad of each and decide on the best option relative to their own situation.
What is recourse factoring?
Recourse factoring is when a business assumes total liability for the unpaid invoice. When the invoice is sold to the factoring company, the company is guaranteeing the invoice will be paid by its customer. As such, if that customer doesn’t pay, then the company is liable for the entire amount.
This option might include a higher initial payout for the company and a lower fee paid once the entire payment is collected by the finance company. Because the company assumes the risk, the finance company adjusts its payouts and fees accordingly.
What is non-recourse factoring?
On the other end of the spectrum is non-recourse factoring. In this case the company isn’t liable, nor does it guarantee the invoice’s value. However, it might not receive as high an initial payout on the invoice and often pays a higher fee for the transaction once it’s completed.
In this case, the finance company assumes the liability and adjusts their payout value and fee according to the risk they are assuming. This risk is based on the customer’s ability to pay and the overall risk of the industry or market the business operates in.
Whilst businesses have options between these two factoring methods, it must be noted that the company must always measure their risk versus the likelihood that the customer will pay. If the company knows the customer well and can be fairly certain they’ll eventually pay, then using the recourse option might be best.
Whilst non-recourse might not pay as much and can have a higher transaction fee, there’s less risk for the company. Make sure to choose the one that best suits your company’s immediate needs.