What is non-recourse factoring ?

Dear Sai

 

"Factoring" in its simplest form is the discounting of future Receivables the company/seller is expecting due to a "Sale" transaction. Normally, the Sale transaction has to be "contractually" executed by the seller to the buyer so there's no "Performance Risk" attached and where the "Factor" is only assuming the risk of the buyer not paying under an executed transaction. In simple words that means that the seller should have delivered the Goods or Services under the transaction and only seeking funding to cover the credit period given to the buyer.

 

There are two elements to consider: The credit period given by the seller to the buyer (tenure of funding/discounting) and the Discount rate.

 

Having said that, there are two main types of Factoring Receivables:

With Recourse: Where the buyer credit worthiness is in doubt or there's not enough available information about the buyer to assess the credit worthiness. In this case the Factor discounts the seller's Receivables with a condition precedent that if the buyer does not pay in the due date, the Factor "Recourses" back on the seller to recover the money.

Without Recourse: where there is enough information available about the buyer to give the Factor enough comfort to fully take the default risk of the buyer and not to recourse on the seller in case of no collection.

 

For more information about Factoring and how it works, please visit www.menafactors.com/products  

In simple words, it is when a company sells its accounts receivables to a financial institution while the financial institution has not right to claim its money back in case these receivables were not collected, except if the reason of non-collection is caused by the company who originally sold such receivables (e.g. disputes on the goods delivered).

There are three parties directly involved: the factor who purchases the receivable, the one who sells the receivable, and the debtor who has a financial liability that requires him or her to make a payment to the owner of theinvoice. The receivable, usually associated with an invoice for work performed or goods sold, is essentially a financial asset that gives the owner of the receivable the legal right to collect money from the debtor whose financial liability directly corresponds to the receivable asset. The seller sells the receivables at a discount to the third party, the specialized financial organization (aka the factor) to obtain cash. This process is sometimes used in manufacturing industries when the immediate need for raw material outstrips their available cash and ability to purchase "on account". Generally, both invoice discounting and factoring are used by businesses to ensure they have the immediate cash flow necessary to meet their current and immediate obligations.

The sale of the receivable transfers ownership of the receivable to the factor, indicating the factor obtains all of the rights associated with the receivables. Accordingly, the receivable becomes the factor's asset, and the factor obtains the right to receive the payments made by the debtor for the invoice amount, and is free to pledge or exchange the receivable asset without unreasonable constraints or restrictions. Usually, the account debtor is notified of the sale of the receivable, and the factor bills the debtor and makes all collections; however, non-notification factoring, where the client (seller) collects the accounts sold to the factor, as agent of the factor, also occurs. In the UK the arrangement is usually confidential in that the debtor is not notified of the assignment of the receivable and the seller of the receivable collects the debt on behalf of the factor.] If the factoring transfers the receivable "without recourse", the factor (purchaser of the receivable) must bear the loss if the account debtor does not pay the invoice amount.If the factoring transfers the receivable "with recourse", the factor has the right to collect the unpaid invoice amount from the transferor (seller). However, any merchandise returns that may diminish the invoice amount that is collectible from the accounts receivable are typically the responsibility of the seller, and the factor will typically hold back paying the seller for a portion of the receivable being sold (the "factor's holdback receivable") in order to cover the merchandise returns associated with the factored receivables until the privilege to return the merchandise expires.

There are four principal parts to the factoring transaction, all of which are recorded separately by an accountant who is responsible for recording the factoring transaction:

1. the "fee" paid to the factor,
2. the Interest Expense paid to the factor for the advance of money,
3. the "bad debt expense" associated with portion of the receivables that the seller expects will remain unpaid and uncollectable,
4. the "factor's holdback receivable" amount to cover merchandise returns, and (e) any additional "loss" or "gain" the seller must attribute to the sale of the receivables. Sometimes the factor's charges paid by the seller (the factor's "client") covers a discount fee, additional credit risk the factor must assume, and other services provided.[15] The factor's overall profit is the difference between the price it paid for the invoice and the money received from the debtor, less the amount lost due to non-payment.

The company can finance itself without resorting to banks

Offering stock

 

Some quotas and sell to other companies