The Invoice Factoring Basics
Invoice factoring is a popular way for businesses to improve cash flow by selling accounts receivable invoices to a third party. That company then forwards the face value of the invoice less its processing and potential interest fees. The buyer also becomes responsible for collecting payment from the original customer when it becomes due. While most people understand this basic premise, some confusion remains about the difference between recourse and non-recourse invoice factoring.
When you sell an invoice to a third party and the original customer defaults on payment, you are legally liable to purchase the invoice back under a recourse factoring agreement. However, it’s not in the buyer’s best interest to force you to do this without offering an alternative solution. The following are some common solutions to this problem for parties that have a recourse invoice factoring agreement:
- The merchant can pay the invoice in installments
- The original holder of the invoice can replace it with a new one from a less risky customer
- Pay towards the invoice using the reserve, which is the percentage the buyer withholds to cover fees.
With this type of invoice factoring, the buyer assumes all risk if the customer owing to the invoice defaults on payment. This also provides you with the legal protection of not having to purchase the invoice back from the buyer if that company declares bankruptcy.
However, you will need to pay the invoice total to your buyer if the reason your customer refuses to pay it is due to a dispute with your company. One last thing to keep in mind with non-recourse factoring is that fees associated with obtaining this type of funding are higher due to the increased risk incurred by the buyer.
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If you’re in need of business financing, we invite you to contact Fintrus to learn more about the many options we can offer you.