Factoring is a contract whereby a party, called a “factor”, purchases, for a certain period of time and for consideration, receivables not yet due that a company (generally one that sells goods) claims from its customers.
Through factoring, the company obtains liquidity for its business.
It is thus a solution that involves three parties:
Anyone who owns a business is well aware that securing payment of invoices can sometimes be a protracted process that gives rise to situations of poor liquidity and financial tension. Factoring may be the right solution to this problem for SMEs.
Factoring is a financial instrument that allows a seller to sell its invoices to a bank or factoring company, called a “factor”, which then collects them from the debtor.
There are two types of factoring that a company may decide to resort to in order to obtain immediate liquidity: factoring with recourse and without recourse. Here are the advantages of each instrument, along with the differences between them.
Factoring with and without recourse are two approaches to selling receivables distinguished by the factor’s obligations. Let us look at each to identify the advantages and disadvantages for the parties involved.
The two products differ mainly in terms of whether the debtor offers a guarantee against default.
Factoring with recourse is a financial instrument whereby a company sells its receivables to the factor but retains liability if the debtor does not fulfil its obligations. This means that the seller agrees to pay the debt if the debtor becomes insolvent. In this case, the factoring company or bank merely collects and administers the receivables, without any guarantee in the event of insolvency.
It is thus the perfect tool for companies that have business relationships with virtuous companies or have perhaps already insured their customers.
The advantages of factoring with recourse for the seller include the possibility of quickly factoring receivables, which will be immediately available to optimise cash flows, above all in the short term.
In contrast, a company that chooses factoring without recourse will immediately be released from all forms of liability in the event of default by the debtor, obtaining cash that can be spent right away in return for a management fee. The factor thus purchases the receivable outright and collects it directly. This allows the seller to consolidate its financial position by immediately obtaining the cash generated by the factored receivable.
Clearly, the guiding criterion for choosing between the two types of factoring is the seller’s risk appetite, through the seller must also take other factors into account: the amount due, the need to improve balance sheet ratios and the urgency of its liquidity needs.
So, how to choose between the two?
This is because in factoring with recourse the company gives up part of the receivable to receive the funds quickly, whereas factoring without recourse requires a longer evaluation phase, as the factor must have time to verify and analyse the debtor’s profile and solidity.
In any case, it is important to choose to rely on a reliable, efficient financial partner able to assist the seller not only in choosing the most instrument most suited to its needs, but also in the day-to-day management of liquidity – just like Ifis Finance.
