When considering invoice finance as a borrowing option for your business, one of the first decisions you’ll need to make is whether factoring or discounting is more suitable. Factoring involves handing over control of your sales ledger to the lender. You sell outstanding debts to the factoring company, who collect payments from your customers.
Invoice discounting is a shorter-term option with a similar principle, but your customers continue to make payment to your own business rather than the lender, and you control your own collection procedures.
Once you’ve decided which type of debt finance is right for your business, you’ll need to choose between an agreement with recourse, or a non-recourse arrangement. So let’s look more closely at each of these options so you have a better idea of which one you should choose.
Invoice factoring with recourse means that you remain liable for debts not paid by your customers. If the lender is unable to collect payment, you’ll be required to refund the cash advance for that particular invoice.
You may find that recourse factoring is cheaper than the alternative, but this is because you are taking on all the risk. Additionally, a factoring agreement with recourse usually means that a higher percentage of each invoice is made available because the lender knows they can legally reclaim the money if necessary.
Whether or not you prefer to take on this risk depends on the past payment history of your customer base. If you are confident that customers will pay in the main, then factoring with recourse could be the best option.
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Non recourse factoring
If a lender is offering you a factoring or discounting agreement without recourse, they are accepting full liability for non-payment of your customers’ debts. This arrangement would be suitable if there is an element of doubt about their ability to pay, either now or in the future.
The terms of a non recourse invoice finance agreement incorporate the additional risk taken on by the lender. These include higher fees and a lower cash amount advanced, so you wouldn’t have immediate access to as much cash.
Additionally, if there is a genuine dispute or query with an invoice, it wouldn’t be covered by the terms of a non recourse agreement.
How does a lender assess their level of risk?
Various parameters are used by a factoring company to assess their level of risk:
Industry in which you operate – some are viewed as greater risk because of inherent invoicing and payment timescales
Size of your customer base
Number of invoices sent out each month
History of payment collection, and efficiency of your systems
Level of bad and doubtful debts
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When compared with other forms of lending, invoice finance is relatively low risk. Choosing non recourse invoice discounting or factoring increases the risk for the lender, but it can be difficult to know if this is the best option for your business.