Recourse and Non-Recourse Factoring

FACTORING
Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts
receivable (i.e., invoices) to a third party (called a factor) at a discount. Factoring is commonly
referred to as accounts receivable factoring, invoice factoring, and sometimes accounts receivable
financing. 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 the invoice.
Factoring can broadly be defined as an arrangement in which receivables arising out of sale of
goods/ services are sold to the “factor” as a result of which the title to the goods/services
represented by the said receivables passes on to the factor. Hence the factor becomes responsible
for all credit control, sales accounting and debt collection from the buyer (s).
Glossary of Terminology
The common terminology used in a factoring transaction are as follows:
i. Client: He is also known as supplier. It may be a business institution supplying the goods/services
on credit and availing of the factoring arrangements.
ii. Customer: A person or business organisation to whom the goods/ services have been supplied on
credit. He may also be called as debtor.
iii. Account receivables: Any trade debt arising from the sale of goods/ services by the client to the
customer on credit.
iv. Open account sales: Where in an arrangement goods/ services are sold/supplied by the client to
the customer on credit without raising any bill of exchange or promissory note.
v. Eligible debt Debts:, which are approved by the factor for making prepayment.
vi. Retention: Margin maintained by the factor.
vii. Prepayment: An advance payment made by the factor to the client up to a certain percent of the
eligible debts.
FORMS/TYPES
A number of factoring arrangements are possible depending upon the agreement

reached between the selling firm and the factor.
1. Recourse and Non-recourse Factoring

Recourse factoring is the basis on which receivables are sold to the factor with the understanding
that all credit risks would be borne by the firm.
In this arrangement, the factor has recourse to the client (selling firm) if the receivables purchased
turn out to be bad, Let the risk of bad debts is to be borne by the client and the factor does not
assume credit risks associated with the receivables.The factor has a right to recover the funds
from the seller client in case of such defaults as the seller takes the risk of credit and
creditworthiness of buyer.
Non-recourse factoring, the risk or loss on account of non-payment by the customers of the client
is to be borne by the factor and he cannot claim this amount from the selling firm. Since the
factor bears the risk of nonpayment, commission or fees charged for the services in case of non-
recourse factoring is higher than under the recourse factoring. The additional fee charged by
the factor for bearing the risk of bad debts/non-payment on maturity is called del credere
commission.
2. Advance and Maturity Factoring
Under advance factoring arrangement, the factor pays only a certain percentage (between 75 % to
90 %) of the receivables in advance to the client, the balance being paid on the guaranteed
payment date. As soon as factored receivables are approved, the advance amount is made
available to the client by the factor. The factor charges discount/interest on the advance payment
from the date of such payment to the date of actual collection of receivables by the factor. The
rate of discount/interest is determined on the basis of the creditworthiness of the client, volume of
sales and prevailing short-term rate.
Sometimes, banks also participate in factoring transactions(Extension of advance factoring-Bank

participation factoring). A bank agrees to provide an advance to the client to finance a part say
50% of the (factored receivables - advance given by the factor).
In case of maturity factoring (also called collection factoring), no advance is paid to client and the
payment is made to the client only on collection of receivables or the guaranteed payment data as
the case may be agreed between the parties.
Thus, maturity factoring consists of the sale of accounts receivables to a factor with no payment
of advance funds at the time of sale.
3. Conventional or Full Factoring

Under this system the factor performs almost all services of collection of receivables,
maintenance of sales ledger, credit collection, credit control and credit insurance. It is also known
as Old Line Factoring. In advanced countries, all these methods are popular but in India only a
beginning has been made. Factoring agencies like SBI Factors are doing full factoring for good
companies with recourse.
4. Domestic and Export Factoring

The basic difference between the domestic and export factoring is on account of the number of
parties involved.
In the domestic factoring three parties are involved, namely:
The import factor acts as a link between export factor and the importer helps in solving the
problem of legal formalities and of language.
1) Customer (buyer)
2) Client (seller)
3) Factor (financial intermediary)
All the three parties reside in the same country.
Export factoring is also termed as cross-border/international factoring and is almost similar to

domestic factoring except that there are four parties to the factoring transaction. Namely, the
exporter (selling firm or client), the importer or the customer, the export factor and the import
factor. Since, two factors are involved in the export factoring, it is also called two-factor
system of factoring.
5. Limited Factoring
Under limited factoring, the factor discounts only certain invoices on selective basis
and converts credit bills into cash in respect of those bills only.
FUNCTIONS OF A FACTOR
The purchase of book debts or receivables is central to the function of factoring permitting the
factor to provide basic services such as :
1. Administration of sellers’ sales ledger.
2. Collection of receivables purchased.
3. Provision of finance.
4. Protection against risk of bad debts/credit control and credit protection.
5. Rendering advisory services by virtue of their experience in financial dealings with customers.
These are explained as under.
1. Administration of Sales Ledger

The factor assumes the entire responsibility of administering sales ledger. The factor maintains
sales ledger in respect of each client. When the sales transaction takes place, an invoice is
prepared in duplicate by the client, one copy is given to customer and second copy is sent to the
factor.
Periodic reports are sent by factor to the client with respect to current status of receivables and
amount received from customers. Depending upon the volume of transactions, the periodicity of
report is decided. Thus, the entire sales ledger administration responsibility of the client gets
transferred to the factor.
2. Collection of Receivables
The factor helps the client in adopting better credit control policy. The main functions of a factor
is to collect the receivables on behalf of the client and to relieve him from all the
botheration/problems associated with the collection.
3. Provision of Finance
Finance, which is the lifeblood of a business, is made available easily by the factor to the client.
4. Protection Against Risk

This service is provided where the debts are factored without recourse. The factor fixes the credit
limits (i.e. the limit up to which the client can sell goods to customers) in respect of approved
customers. Within these limits the factor undertakes to purchase all trade debts and assumes risk
of default in payment by the customers.
5. Advisory Services
These services arise out of the close relationship between a factor and a client. Since the factors
have better knowledge and wide experience in field of finance, and possess extensive credit
information about customer's standing, they provide various advisory services on the matters
relating to :
(a) Customer's preferences regarding the clients products.
(b) Changes in marketing policies/strategies of the competitors.
(c) Suggest improvements in the procedures adopted for invoicing, delivery and sales return.
(d) Helping the client for raising finance from banks/financial institutions, etc

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FACTORING

The common terminology used in a factoring transaction are as follows:

vi. Retention: Margin maintained by the factor.

A number of factoring arrangements are possible depending upon the agreement

1. Recourse and Non-recourse Factoring

2. Advance and Maturity Factoring

Sometimes, banks also participate in factoring transactions(Extension of advance factoring-Bank

3. Conventional or Full Factoring

4. Domestic and Export Factoring

Export factoring is also termed as cross-border/international factoring and is almost similar to

1. Administration of Sales Ledger

4. Protection Against Risk

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