Invoice factoring is the practice of “selling” your invoices, or accounts receivable, to a company that then pays you right away for that invoice, minus a fee. This gives you cash flow you can use to pay bills, finance operations, take on new business, and handle business expenses as they come up. Factoring companies also often handle the back-office details of collecting your invoices, so you don’t have to track and chase down payments. This not only saves you money but valuable time.
There are two types of factoring: recourse and non-recourse freight factoring. The difference between the two, besides the cost, is what happens if customers don’t pay your invoices in a timely manner. Here are the details you need to know to make the right choice for your business.
Recourse factoring is the most common type of factoring businesses use. While you may have sold the invoice to a factoring company, you are still ultimately responsible for collecting the balance if the factoring service encounters issues.
While the factoring company should make every reasonable attempt to collect for you, if your client refuses to pay in a timely manner, you must buy that invoice back from the company and take over collection efforts yourself.
The advantages of recourse factoring
Here’s why you might want to consider recourse factoring:
- It’s less expensive.
- Technically, it is not a loan, so there is no debt on your balance sheet.
- You don’t have to handle collections unless your client does not pay.
- If you already have credit monitoring and qualification practices in place, recourse factoring may be a good solution for you.
The disadvantages of recourse factoring
Entering into a recourse factoring agreement does come with some risk. If your customer does not pay, you do have to buy back that debt and collect it yourself. This buyback can have a huge impact on your cash flow, depending on your situation at the time. If you can’t pay back the invoice, you might end up in collections yourself, which could impact your credit rating.
It’s important to be aware that there are ways to minimize this risk. But it can still come into play from time to time with recourse-factored invoices.
Which businesses should use recourse factoring?
Your business should use recourse factoring if:
- You have creditworthy clients who pay on time and reliably.
- You want to pay lower fees and sell invoices at the lowest rates.
- You can easily repurchase invoices in case your client fails to pay.
In short, stable businesses with a good cash flow plan are best for recourse factoring.
Non-recourse factoring is when the factoring company takes on the ultimate responsibility for debt collection. In this scenario, your client’s creditworthiness is more important than yours. For that reason, newer companies that have not yet developed business credit often choose non-recourse factoring.
The advantages of non-recourse factoring
- Working capital, usually available the same day
- No additional debts
- Someone else does your collections for you
- Relatively easy to qualify for
- Can be used as short-term funding
- Allows you to provide more generous payment terms to clients (like net-30)
Disadvantages of non-recourse factoring
- More expensive
- The only protection is from client bankruptcy in many cases
The primary disadvantage of non-recourse factoring is the cost. Generally, non-recourse factoring is more expensive than recourse factoring. The higher price serves to protect the factoring company from potential bad debt.
It is also important to understand that usually, the recourse clause protects you if the client who owes you declares bankruptcy. Otherwise, you might pay more and still be required to buy back some invoices anyway. The level of protection varies by company. The more protection they offer, the higher the cost.
While non-recourse factoring is not the answer for everyone, it works exceptionally well for some businesses.
Which businesses should use non-recourse factoring?
- New businesses with little or no credit might find it easier to qualify for non-recourse factoring.
- Businesses that have clients with a high risk of nonpayment or are a credit risk.
- Sole proprietors also often benefit because it takes accounts receivable work off their plate.
Remember to look carefully at each provider’s terms and options to find the right factoring choice for you.
Hybrid factoring model
A hybrid factoring model is a factoring type that combines the best of both recourse and non-recourse factoring. You can choose to factor only a specific portion of an invoice using both recourse and non-recourse factoring. This means the cost falls somewhere between the two types of factoring and that you and the factoring company share some of the risks.
Hybrid factoring can be easier to qualify for than full non-recourse factoring. It can be a good option if you have a mix of credit-worthy clients and those who are less reliable. It can be used whether you factor some of your invoices or all of them.
In a similar technique, some companies will factor some of their invoices and not factor others, depending on cash flow needs and the client they are billing. Whether or not you can do this and how practical it will be for you depends largely on the factoring company you choose.
Recourse vs. non-recourse factoring: Which is better?
In general, this is a question you will have to answer based on your company and your circumstances. Each method had different costs, advantages, and disadvantages. It’s hard to define one form of factoring as better than the other from an accounting perspective. However, there are some questions you can ask yourself:
- How creditworthy is this client?
- Can I absorb the costs of factoring and still be profitable long-term? (If not, you may want to look at the rates you are charging).
- Do I need working capital now, or can I wait for payment?
- What kind of risk can my company handle?
- Does my factoring company handle slow payments? How soon will I have to buy back unpaid invoices?
- What circumstances does non-recourse factoring cover, and how likely are those to occur?
- Should I factor all of my invoices by recourse or non-recourse factoring, or should I take a hybrid approach?
Time and money are usually the major things to consider. Can you be doing something better with your time than billing clients and tracking and chasing down payments? Is it worth any fees you are paying to not have to do those things?
Most often, factoring of some sort will free up your time and money. More time allows you to focus on running your business, finding new clients, and handling other day-to-day operations outside of accounting and invoices. The type of factoring you choose may also change over time as you acquire new, and hopefully more reliable, clients.
Find the right factoring company for your business.
How do you find the right factoring company for your particular operation? Get the facts and debunk the myths by visiting Truckstop.com. You’ll learn that:
- All factoring companies are not alike.
- You don’t have to factor every invoice.
- Our factoring does not lock you into any long contracts.
Once you understand the facts about factoring, get in touch. We’re here to help with all of your truck business factoring needs. Schedule a demo today!