The role that non recourse factoring companies have is to purchase a financial asset from clients. This means that they will buy a client’s debtors invoice list. It is not a loan per as it is not based on the customer’s credit worthiness or the value of the company. It is based solely on the value of the client’s accounts receivable book.
This is a method used by many businesses to raise cash to inject into their business. The company will make a decision to do this when they feel that it would serve them better to use the money they can acquire through factoring to increase production or sales. It is often beneficial for them to do this rather than to carry another company’s debt.
When a client approaches a factor to try and sell their accounts receivable book, there are some serious decisions to be made by the factor. They will have to find out if the debtors are credit worthy and able to meet their debt obligations. They can take out insurance to cover them for a loss if the client’s debtor becomes bankrupt and thus not able to settle his debts.
Small companies who use factoring will normally request that their customers pay the amounts payable to the factor. This then means that the factor takes responsibility for the outstanding amounts as well as takes the risks involved. The risks include instances where the debtor is insolvent and then cannot pay his debts. In this case, the factor cannot claim the monies from the client. Factors would offer two choices to a client. One of them is called recourse and in this case; the client remains responsible for bad debts. The other is called non-recourse, and this is when the factor takes all the responsibility for any bad debts and cannot claim the amount from the client.
There are risks that are involved in factoring. There could be client fraud like fake invoices and pre-invoicing. Sometimes there are payments that have been misallocated in the client’s accounting system. Sometimes credit notes have not been assigned to the debtor. To avoid these risks, fraud insurance can be bought and doing an audit of the client’s books is another idea.
Sometimes the debtors’ amounts will be incorrect because of contractual disputes. There are other differences that could exist. For example, goods that have been invoiced and not delivered or the debtors have received damaged goods and these issues have not been sorted out.
If a cash injection is required in a company, it is often easier to go to non recourse factoring companies versus a bank. If you apply for a loan and depending on your credit rating, you may require collateral. Ensure that your accounting system is in good shape before you approach a factor.