Invoice factoring is a way to fund cash flow by selling invoices to a third party, which can be an independent finance provider or a bank. The business enters an agreement with the factoring company and the company will manage the sales ledger and credit control for a fixed period or an ongoing basis. When the customer comes to pay, the factoring company will collect the debt and deduct their fees. The balance is then given to the business client.
Factoring companies can unlock funds that are tied up in unpaid invoices without waiting for customers to pay. This solves cash flows issues for retailers and manufacturers. However, factoring companies can prove to be quite expensive. Many factoring companies are not suitable for small businesses because of their interest rate and administration fees.
If an invoice goes unpaid, the responsibility to settle the debt falls in the hands of the business. Most factoring companies include a legal recourse clause to protect themselves from unpaid debts. There are non-recourse and recourse factors. Recourse factors mean that the business client assumes responsibility for unpaid invoices and must settle the debt.
Non-recourse factors means that the factoring company assumes the risk of non-payment by the customer. There are risks associated with the non-recourse factors. This kind of recourse opens a gateway for fraud. Non-recourse factoring companies will be more diligent about doing their research on potential clients before lending money. Since there is a higher risk associated with this sort factoring, non-recourse factoring companies are more expensive.