Main Product Types
By volume, Recourse Factoring is the most widespread and common form of domestic factoring available.
The Factor will purchase the invoices of the Seller, provide funds to the Seller against approved debts receivables and collect money from the Buyers as the debts fall due. The Factor assumes responsibility for the maintenance of the sales ledger by:
- chasing debtors
- sending regular statements of account
- allocating payments received against outstanding balances
- regularly reporting the movements on the sales ledger to their clients
With expertise in receivables management, the Factor can provide an extremely valuable service not available with the traditional bank overdraft. However, a Factor is not a debt collection agent, although many will have the ability to employ debt collectors if required. (The difference is that a debt collector is employed to collect a defaulted or impaired debt, the Factor manages live and good debts.)
Factoring arrangements are usually operated on a disclosed basis, so the Seller’s buyers are aware of the Factor’s involvement. A notice is placed on the Seller’s sales invoice instructing customers to make payment directly to the Factor. This is usually referred to as the Notice of Assignment.
Recourse factoring involves making a prepayment to the Seller at an agreed percentage (the prepayment percentage) for a pre-determined period. ‘Recourse’ means that while the Factor is the legal owner (and has the economic right to dispose of the receivable) he can re-sell the receivable back to the Seller. Accordingly, the Seller might consequently still be at risk should its customer become insolvent or cease to trade. It also means that the debt is funded for a pre-determined period, typically 90 days after due date of the receivable. If the invoice has not been paid at the end of this period, any prepayment may be withdrawn and repayment may be required from the Seller. This is typically deducted from the prepayment created by more recent invoicing or from Buyer payments received.
Sellers remain responsible for undertaking their own credit research and they choose which Buyers they will give credit terms to (and to what level) but this will typically be done with the advice and support of the Factor who will generally have access to credit information and can advise accordingly.
The Seller is also responsible to ensure that the invoice is payable in full; in the event of a dispute it will be liable to repay the factor the purchase price that has been received in advance.
In some “Recourse Factoring” Contracts, the Seller may have a Credit Insurance policy in place that protects against bad debts. In this situation, the benefit of the policy is then assigned to the Factor (who owns the insured receivables) who will use the credit insurance policy for its own risk monitoring. In this case the With Recourse Factoring + credit insurance mechanism is very similar for the Seller as the Non-recourse Factoring mechanism.
Non-recourse factoring operates in most senses like recourse factoring and offers the same services. In addition, the Factor accepts the financial credit risk of the Seller’s buyers failing and takes responsibility for any bad debts up to individually agreed limits. Funding is therefore not withdrawn after a specific period.
Each Buyer is carefully researched by the Factor and a specific ‘debtor limit’ applied. Subject to confirmation, the Factor will class invoices up to this limit as ‘approved’ and any trading in excess of the limit is usually at the Seller’s risk. All invoices within the agreed debtor limit are subject to bad debt protection, which means that any bad debt loss is absorbed by the Factor rather than the Seller.
The credit cover only relates to credit default non-payment and not to disputes or refusal to pay for other reasons. Just as with Recourse factoring, in the event of a non-credit default, the Seller is required to repurchase the invoice from the Factor.
For this reason, some people prefer to describe the product as factoring with credit protection.
Invoice Discounting (or undisclosed Factoring)
Invoice Discounting is a form of invoice finance that dominates the UK market and is established (and growing) to varying degrees in many other countries.
Invoice discounting is usually a non-disclosed facility, i.e. unlike factoring, the Buyers are not aware of the Factors involvement.
A Factor will purchase the sales ledger and provide funds to the Seller against approved debts but will not undertake the collection of the debt, which remains the responsibility of the Seller.
All Buyer monies are directed to a joint trust or nominated account and the Seller will deposit any/all buyer payments received into that account, and it has no rights to withdraw funds. The Factor will usually transfer those funds to their own account at the close of business each day.
Historically, most invoice discounting facilities were managed on a bulk basis where account level totals rather than each individual invoice were entered onto the Factor’s system. However, improved technology now means that while the Factor will still finance at an account level, invoice level data can be transferred and retained where the Seller accounting software is compatible.
Routine month end reconciliations and regular audits of the Seller are usually applied. If the facility operates on a recourse basis, then third party bad debt cover can be sourced and assigned to the invoice financier if required.
Invoice Discounting is not available in all markets as some jurisdictions may not allow invoice finance where the assignment of each invoice is not notified to the Buyer and some legal systems do not allow nominated bank accounts which are in the name of the Seller but owned and controlled by the Factor.
Other Product variants
There are many more variations on the delivery of Factoring and Invoice Finance but the above three methods represent around 95% of the total global market. In this introduction, we therefore will not cover the other types in detail but simply mention other versions which include:
- Reverse Factoring – where funding is offered to all the suppliers of a single buyer. This is sometimes known as Approved Payables Finance and is important in some markets, especially Spain
- Maturity Factoring – Where funding generally is made available once the invoice is due for payment. This variant is found in e.g.Italy.