In B2B trade, customers may not always be able to pay their invoices on time or not pay at all. To minimise such risks, a company chooses non-recourse factoring to protect itself from bad debts and maintain a continued cash flow.

Meaning of Non-Recourse Factoring

In non-recourse factoring, a factoring organisation assumes responsibility for bad debts if a company’s client does not pay back the invoice or files for bankruptcy. When the factoring organisation takes on the risk of a bad debt, it is known as recourse factoring. Learn more about the differences between these two popular types of factoring here.

How Non-Recourse Factoring Works

In non-recourse factoring, a company sells its unpaid invoices to a factoring company and, in return, gets a percentage of the invoice to help manage its working capital needs. The factor then follows up with the company’s customer for repayment of the invoice. Once the factoring organisation receives the full payment from the customer, the remaining invoice amount is returned to the company after subtracting the factor’s fee. If a customer has not paid back the invoices, the factor assumes responsibility for the bad debt.

Example of Non-Recourse Factoring

Company XYZ has a history of customers not paying their invoices on time or not paying back at all. This causes a burden on XYZ’s cash flow. It sold goods worth ₹20,000 to its customer ABC. XYZ had an urgent requirement for cash to pay off certain expenses. To get an inflow of money to cater to its working capital needs, XYZ goes to a factoring company and opts for non-recourse factoring. The factor asks for a heavier charge from XYZ to secure it against bad debts. XYZ pays the fees and gets a percentage of its unpaid invoices amounting to ₹18000. The factor takes ownership of the invoice and chases it up to the customer to pay back the invoice. However, the customer files for bankruptcy. The factor assumes responsibility for the bad debt, and XYZ continues with its operations.

Benefits of Non-Recourse Factoring

In a non-recourse loan, a lender cannot extract more than the collateral offered by the borrower to get the loan amount.

The benefits of this kind of funding are -

  • Borrowers are not personally liable for the repayment of the loan.
  • As no personal assets of a borrower are in threat of getting seized if a borrower defaults on payment, the borrower has a clean balance sheet.
  • Provides privacy in terms of non-disclosure of liabilities to financial lenders or partners, as the loanee is not personally liable to repay the loan.
  • Processes are quicker than banks as it requires minimal paperwork and documentation.

Disadvantages of Non-Recourse Factoring

Companies should look into certain disadvantages of non-recourse factoring before choosing it as a funding source.

  • The level of security provided by each factoring company varies depending on their offers.
  • A factor chooses which of a company’s unpaid invoices to source, as the factoring companies do not want the high risk attached.
  • More expensive than recourse factoring or bank financing, as they charge a higher fee to cover any bad debts.
  • Has an intrusive dynamic with the company’s client as the factor needs to chase it up to pay their invoices.

When is Non-Recourse Factoring a Good Option?

Non-recourse factoring can be the right choice for companies when they know their customer-profile base is high risk. It helps the company be safeguarded from customers who file for bankruptcy or insolvency. It is also a good option when companies need an immediate influx of cash for their capital requirements, and opting for bank loans can take longer. Sometimes, a bank may not approve a company’s loan request, so choosing non-recourse factoring becomes a viable option.