Types of Factoring
Factoring can be a complicated subject. In researching factoring, a business owner will find numerous providers using different terminology to describe the exact same transaction structure. Frustratingly, two different providers may use the same terminology, but the underlying structures and procedures in the transaction can differ vastly.
Having a basic knowledge of the principles involved and knowing which questions to ask will help you determine the key differences between providers. In order to help you in your efforts, The Southern Bank provides this guide to different types of factoring in order to help you make more informed decisions.
What is Factoring?
Factoring is the sale of accounts receivable by a company to a financier in order to inject near-term liquidity in the business. Factoring differs from a loan in that the accounts receivable are sold rather than used as collateral as is the case for most traditional lines of credit. Factoring or monetizing invoices and accounts receivable accelerates a business’s cash flow and allows that company to operate more effectively. If a traditional line of credit is unavailable or insufficient, factoring helps businesses meet payroll, manage seasonality, invest in new inventory, take on new clients, and generally run their business with more confidence in their cash position.
These illustrations explain how a company’s cash flow changes under a factoring agreement:
What About the Other Types of Factoring?
For the most part, Accounts Receivable Financing, Invoice Factoring, Accounts Receivable Discounting, and Debt Factoring, are synonymous with factoring. That is to say, all of the above terms refer to the same sale and purchase of accounts receivable set forth in the factoring explanation above.
The short answer is that factoring has been around a long time and used in a variety of different industries from textile distribution, to furniture manufacturing, to transportation, to staffing, to just about any and every other business to business industry you can imagine. The result? Lots of names and lots of confusion.
All you really need to keep in mind is that all factoring, or any of the other names it may go by, requires the sale of invoices or accounts receivable to the third party financier.
Recourse Factoring vs. Non-Recourse Factoring
While there are many names for factoring, each type can be classified as recourse or non-recourse. Recourse factoring is much more common, with 79% of factoring companies using recourse factoring, according to a study conducted by the American Factoring Association. So, how do they differ?
Under a recourse factoring agreement, a company is expected to buy back invoices from the financier that remain unpaid by customers after a pre-determined period of time, which typically falls around 90 days. This type of factoring is typically cheaper and preferred when the risk of non-payment from customers is low.
In a non-recourse factoring agreement, the financier assumes the risk of non-payment by the business’s customers, regardless of reason. Non-recourse factoring, as mentioned above, is much less common and, while it can provide insulation against the risk of non-payment, the rates are typically higher and it is offered by fewer factoring providers. Invoices are often insured by the financier and those costs are passed on to the business selling the invoices.
While there are certainly other names for factoring used by financiers, the underlying structure and intended benefits remain the same. Whatever you’d like to call it, The Southern Bank provides our customers the confidence and comfort of working with an FDIC regulated bank offering the best blend of price and customer service to keep your business operating smoothly.