For businesses that need liquidity and already have some sales and revenue momentum, factoring can be a great option.
Factoring of accounts receivable lets such businesses sell their invoices in exchange for immediate cash.
However, there are variations on factoring that vary the balance of risk between the client and the financier known as non-recourse and recourse accounts receivable financing.
With factoring accounts receivables without recourse, the factoring company assumes the credit risk on invoices when there’s non-payment because of the debtor’s insolvency, effectively insulating the client from this credit risk. For instance, if the client had an invoice for Best Buy and the factor provided financing against it on a non-recourse basis, then the factor assumes the risk.
That means if Best Buy files for bankruptcy, the factor loses the advance given to the client against the invoice rather than the client.
That’s a major reason why non-recourse factoring is an attractive option — it offers a level of credit protection. That can be especially critical if the client doesn’t have a great sense of the credit profile or risk of default of their customers.
It also saves the client the expense of seeking and paying for separate credit insurance on accounts receivables.
In this sense, with non-recourse factoring, the factor functions a bit like an outsourced credit department. When a client is looking to add a customer or sell more to an existing customer, it can check with the factor to see how much risk the factor is willing to take on that particular account. The client can use that information to inform its ongoing business decisions including how much business to carry out with that customer.
Such credit assessments can be crucial during financial crises or other times of financial upheaval. The financier is likely to have better information on the credit-worthiness of partners and should be seen as a valuable resource.
Like accounts receivable financing in general, the idea behind non-recourse factoring is that the client can focus on their core business instead of getting mired in the specifics of credit underwriting.