Companies suffering through a cash shortage consider several options. Some companies choose to issue stock or sell partial ownership of the business to investors. This action allows the company to receive cash funding without the requirement of paying it back. It also reduces the current owners' control because the new owners participate in decision making. Other companies borrow money either from a bank or by issuing bonds. This option requires the company to repay the funds along with the required interest payments. Still other companies choose to use the resources they currently own and factor their accounts receivable.
Accounts receivable represents the money that customers owe the company as a result of prior purchases of products or services. The company holds the right to collect payments on these accounts. The accounts rise out of the normal course of business when companies allow their customers to pay 30 or 60 days after receiving the product or service provided by the company.
The process of factoring occurs when a company sells its receivable accounts to an outside company in exchange for immediate payment. The company transfers the rights to collect the money owed on each account to the purchasing company, or factor. Companies choose to factor their receivables for a couple of reasons. Some companies need to receive cash quickly to pay financial obligations that come due. When these companies experience lower than expected sales or unexpected expenses, they must obtain cash to make their payments. Other companies opt to focus on their business operations rather than spend time managing the collection process. Companies that need cash as well as companies that choose not to manage their own collections can factor their receivables.
Factoring With Recourse
When a company factors with recourse, they work with a purchaser, or factor, who pays the company for the right to receive the money collected. The factor reviews the outstanding receivable accounts held by the company and chooses the accounts it wants to purchase. The factor considers which customers are most likely to pay their balances due. When a factor decides to accept these accounts, it can do it with recourse. Factoring with recourse means that the company agrees to compensate the factor for the accounts that the customers do not pay. This limits the potential liability faced by the factor.
Factoring Without Recourse
A factor who enters the agreement without requiring the company to repurchase unpaid accounts chooses to factor without recourse. This means that once the factoring transaction is completed, the company holds no further liability to the factor. These factors usually charge more and select their accounts more carefully to compensate for the higher risk.