- 27 Apr
How Recourse Factoring Works
One of the concerns customers sometimes have about using factoring is the worry that they will have to repay the finance against a particular invoice, if the debtor doesn't pay them. This is because the most common form of invoice finance is what we call "recourse" or "with recourse". This means that if an invoice isn't paid after a set period, you have to repay the funding to the factoring company.
We have known customers not to proceed as they are worried about this aspect of using factoring, however this problem can be overcome or mitigated against.
How Recourse Factoring Works
How recourse factoring works is that you have, what is known as a recourse period. This could be 90 days from the end of the month in which the invoice was raised, for example. This means that if you raise an invoice today, 27th April, the end of the month (30th April), plus 90 days would be 29th July. Therefore, if the debtor hadn't paid their invoice, dated 27th April, by 29th July, you would have to repay the finance to the factoring company.
An Example Of How Recourse Works
So if the invoice was for say £100, with an 85% prepayment you would raise the invoice on the 27th April and, with the right provider, you could get funding that day of £100 x 0.85 = £85, as if the invoice had been part paid immediately. Your availability with your factor would be £85 (ignoring charges for the sake of ease). You could draw a payment of that £85 into your bank account. If you have a large sales ledger of outstanding invoices, you can then scale up that funding against all that are eligible.
Now after you draw the availability of £85, your availability becomes £0. If we assume that your customer never pays, on the 29th July that invoice will recourse (exceed the recourse period) and your availability will become -£85 i.e. you will be overdrawn.
Avoiding The Effects Of Recourse
Now you could repay that money, or as is more often the case, new invoices have been raised, they increase your availabilty and effectively cover that deficit. In this example, another new invoice for £100 will generate enough availability to return your available funding to £0.
The other way to avoid the issues of recoursing invoices is to take the "non recourse" option (also known as bad debt protection).
Non Recourse - Bad Debt Protection
The simplest, most secure answer is to take the non recourse factoring option i.e. factoring without recourse. With this type of facility, the factoring company will issue you with a credit limit in respect of each new customer. Providing your level of invoicing outstanding to that customer remains within that limit, you will not experience recourse as you will be protected against the customer becoming insolvent and being unable to pay you.
Cost Of Non Recourse
There is a small additional charge for the protection that comes with non recourse. This is called the CPE or "credit protection element" and is typically starts from about 0.4% (+ VAT if applicable) of the value of invoices factored. There are also a few offers available that will reduce the cost of the CPE element. This can be a small price to pay for the peace of mind of knowing that your are protected against bad debts and the effects of recourse.