When it comes to debt collection and unpaid invoices, there are many ways a business can collect what is owed to them.
Businesses can attempt to collect debt internally, putting a lot of time and resources into establishing processes and procedures, or they can use a debt collection agency that already has these processes in place.
Using a debt collection company saves time and money, but what are some of the ways they can help a business? That’s where transactions like recourse factoring come in. They are used to give businesses peace of mind in their collection efforts.
This wide-ranging blog will cover what to expect from a debt collection agency that can offer factoring services, why a business would want recourse factoring or non-recourse factoring, and other types of factoring that may benefit a business that has unpaid invoices.
What Does A Factoring Company Do?
While every factoring company will operate differently and offer a variety of services to suit business needs, many factoring companies are effectively debt collection agencies.
Factoring, specifically, is a way to raise money by selling unpaid invoices and debt to a factoring company or other financial institution.
There are some other financial services that they may offer, however. Those include things like managing accounts receivable and helping businesses put together comprehensive debt collection plans.
A few of the services offered by factoring companies are:
- Commercial Debt Recovery: Commercial debt recovery encompasses many different financial and legal transactions. When it comes to unpaid invoices, those collection activities may include demand letters, phone calls to the delinquent business, and legal forwarding.
- Accounts Receivable Management: The best way to prevent debt is with a solid accounts receivable management plan. This means knowing when to use internal collection activities and when to turn over an account to a debt collection agency.
- Legal Forwarding: In the event that non-payment continues, and past due invoices accrue – along with any interest and fees – businesses may need to be involved in some type of legal activity. A debt collection agency will have vast resources for legal forwarding.
Of course, every business will have different needs, but most factoring companies will offer a variety of debt collection choices for businesses to choose from.
The Difference Between Recourse Factoring and Non-Recourse Factoring
There are several different types of factoring available through various factoring companies and other financial institutions. Two broad categories that should be understood first are recourse factoring and non-recourse factoring.
Recourse factoring means that in the continued event of non-payment once an account goes to collections, the original holder of the debt will buy back all of the accounts that remain unpaid. The debt is usually sold to a factoring company at a discount as a way to cover unpaid invoices. All of the liability remains on the client, not the factoring company.
Non-recourse factoring, on the other hand, means that the factoring company holds the liability in the event of non-payment. Debt is purchased from businesses and the business has no other risk with respect to that debt. All of the liability remains with the factoring company, not the client.
How Does Recourse Factoring Work?
Recourse factoring is simple. If a business has $20,000 in unpaid invoices each month that they want to collect on, they would sell those invoices to a factoring company or debt collection agency for a discounted price. In this example, the discounted price will be $15,000.
The factoring company attempts to collect on the debt for a specified period of time. After that time period has expired, the business will buy back whatever debt wasn’t collected. If all of the money is collected, they don’t have anything to buy back and may be owed additional money, depending on the agreement with the factoring company.
How Does Non-Recourse Factoring Work?
Non-recourse factoring works a bit differently. If a business has $20,000 in unpaid invoices each month that they want to collect on, they would sell those invoices to a factoring company or debt collection agency for an agreed-upon price. In this example, the discounted price will be $10,000.
Because the factoring company takes all of the risks, they may want a much steeper discount on the unpaid invoices. The business will not buy anything back as the factoring company will continue to collect on the debt for as long as their policy states.
3 Other Types of Factoring that Benefit Businesses
In addition to recourse factoring and non-recourse factoring, there are other types of factoring that can be used to take care of unpaid invoices. Each of these has benefits and risks associated with them, so compare the option wisely.
1. Advance Factoring (Financing Facility)
Advance factoring – also known as financing facility – is when a business receives an advance on uncollected or not-yet-due receivables. There is usually an applied interest rate, as well.
Typically, a business won’t receive the full amount of the uncollected receivables but will receive a discounted rate for them. The balance is paid on an agreed-upon date in the future.
For example, a business may have $20,000 a month in uncollected invoices they need an advance on. They receive advance factoring that gives them $15,000 upfront and the remaining 30 days after the receivables have been collected. Any interest fees will be deducted from the balance or paid upfront, depending on the arrangement.
2. Maturity Factoring (Collection Factoring)
In a maturity factoring situation, also known as collection factoring, the factoring company or debt collection agency will provide the business with funding on a specific collection date or on the day of the payment of the receivables, typically whichever is earlier.
There is no money paid in advance with maturity factoring. All funding is provided by the time the receivable is paid.
For example, a business may have $20,000 a month in invoices that are to be collected by the end of the month. With maturity factoring, the business sells those invoices to a factoring company at the end of the month, or at an earlier specified collection date, and the business receives funding at whatever the agreed-upon price is.
3. Reverse Factoring
Reverse factoring offers a different approach to invoice financing. In this type of situation, there are three parties involved: a buyer, a supplier, and a financial institution or factoring company.
The buyer places the order with the supplier (the business in this example), the business sells the invoice to the factoring company at a discounted rate, and then the buyer pays the factoring company at an agreed-upon date.
For example, a buyer may purchase $20,000 in products from a business and want to use reverse factoring. The business works with a factoring company, sells the invoices to them for $18,000, and the factoring company collects the payment from the buyer when it’s due.
Why Businesses Want to Use Recourse Factoring
With all of these different types of factoring – and there are more – it can be a challenge to figure out what is best for a given situation. Why would a business want to use recourse factoring over one of the other options? Is there a better option than recourse factoring? What is really the benefit of it?
- Recourse financing is a quick and easy way to receive funding for unpaid invoices – and it’s risk-free. All a business needs to do is buy back their unpaid invoices.
- Unpaid invoices that are purchased back can be sold to another debt collection agency or factoring company. Beyond any state regulations, there may be no limit selling the debt until it’s paid.
- Because the risk stays on the client or business that sells the unpaid invoices, the rates are likely to be more competitive with recourse financing. This is the most cost-efficient way to recover debt.
Each of the factoring types mentioned in this blog has benefits and drawbacks. Every business and debt situation will be unique. Recourse financing stands out as one of the most cost-efficient and risk-free ways to receive funds for unpaid invoices.