Recourse In Factoring Meaning Overview Example With Journal Entries

Recourse in Factoring Meaning

It is the selling of account receivablesAccount ReceivablesAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more by a company to a factor at a discount. The factor pays a percentage of the account receivable to the company. Later, after collecting the total amount from the debtor, the balance amount (net of the discount) passes to the company.

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Example of Recourse in Factoring

Suppose Company A sells $100 worth of goods to Company B on 1st May, who is to pay back on 31st May. Now Company A sends the invoice copy to the Factoring Company, which sends $80 to Company A. On 31st May, the Factoring company collects $100 from Company B and transfers the balance (100-80-5 = 15) $15 to Company after keeping $5 as factoring fees.

Let us get into the two major types – recourse and nonrecourse factoring.

Recourse time is the amount of time for which the Factoring company will keep the invoice open. In this, tTA debtor is a borrower who is liable to pay a certain sum to a credit supplier such as a bank, credit card company or goods supplier. The borrower could be an individual like a home loan seeker or a corporate body borrowing funds for business expansion. read morehe seller has to pay back the factor in case of non-payment by the debtorsDebtorsA debtor is a borrower who is liable to pay a certain sum to a credit supplier such as a bank, credit card company or goods supplier. The borrower could be an individual like a home loan seeker or a corporate body borrowing funds for business expansion. read more. In other words, the seller assumes the risk of any uncollected invoices. In other words, if the customer is not paying after the recourse time has passed, the Factoring Company has the option to charge back the entire invoice from the seller.

Let us look at an example to understand this concept.

Company A sells $1000 worth of goods to Company B, which will pay Company A back after six months. Company A also sends a copy of an invoice to a Factoring Company, which transfers $850 to Company A on the same day. After six months, the Factoring company collects $1000 and, after deducting a 10% commission of $100, returns the balance amount of $50 (1000-850-100=50) to Company A.

The journal entries for Company A would look like this.

On the other hand, in non-recourse factoring, the factor absorbs the risk of non-payment by borrowers. Since it is riskier, the transaction fees paid to the factor are higher than in recourse factoring.

For the same example explained above, if we assume factor fees to be 20% (it is generally much higher due to the high risk involved), the journal entries for Company A will look like this.

Difference Between Recourse and Non-Recourse Factoring

Advantages

It is a easy to advance money on account receivables and build up cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more.It also transfers the hassle of collecting payments from debtors to a third party so that the seller can focus on its core business.It is much cheaper for the seller since factor fees are low.Since the factor does not bear the risk, recourse factoring is readily available in the market and has faster approval.

Disadvantages

Since the seller bears the entire risk of default, the seller must perform proper due diligence on the customer’s credit profile.It may heavily affect the seller’s financials if the customer defaults on a large sum

Conclusion

Companies should depend upon two main factors before deciding on which type of factoring to go for. Firstly if the amount of account receivable is low, the seller can afford to risk non-payment and opt for recourse factoring. Also, if the seller has a good relationship with the customer and is confident about its debt repayment ability, recourse factoring is preferred. Finally, it is very important to define and understand the factoring agreement’s terms clearly. Even in non-recourse factoring, the Factoring Company might agree to pay only if the customer has declared bankruptcy and not if the customer is not paying or has run away with the money.