The modern transportation market creates new business opportunities for all its participants. This is one reason why recourse vs nonrecourse freight factoring have been gaining popularity in recent years. But why are they quickly becoming the preferred choice among other financial tools, and what pitfalls are hidden here? Let’s find out.
To put the definition of freight factoring in simple words, it is the transfer of rights to receive payment according to the invoice from a creditor (broker, freight carrier or owner-operator) to a third party (factoring agent) instead of the client. Like any other type of financial tools, freight factoring involves some risks, depending on which of the available options you choose — factoring with and without recourse. The difference between them is on whose “shoulders” the risks lie, or from whose “pocket” the payment will be reimbursed.
- What Is Recourse Factoring?
- What Is Non-recourse Factoring?
- Difference Between Recourse and Non-recourse Factoring
- How to Use Factoring for Cash Flow?
- Choosing Between Recourse or Non-recourse Factoring
What Is Recourse Factoring?
This is a type of financing, where a factoring company pays off the amount of invoice to a creditor and provides the services for managing and collecting accounts receivable, but at the same time it does not assume credit risks.
It means that a transporter will deal with its debtor in case of non-payment and will spend its cash flow to pay a refund to a factoring company. All that meaning that this is the most attractive financial tool for those trucking companies that have reliable and trusted customers. In fact we can say that a factoring company finances your customer’s accounts with deferred payment.
As far as the recourse factoring is concerned, the factoring fees will be less because transport companies hold all the risks. At the same time, risk insurance is provided to ensure security and reduce stress for all participants.
What Is Non-recourse Factoring?
This is a type of financing, when a transport company transfers the debt into the hands of a factoring agent, and in case of non-payment, the problem will become a headache for the factoring company, as it fully assumes credit risks.
Conditions of non-recourse factoring are undoubtedly more convenient for transport companies. However, a factoring company, while taking the risks, will be more demanding when making a check on transaction and will take the fees higher.
With a non-recourse option, financing is normally divided into smaller parts — up to 70% at first, and the balance after the full repayment.
This option is good for those truckers who plan to cooperate with customers from other regions and cannot check the financial condition of a potential counterparty, or do not have qualified personnel to manage receivables.
Difference Between Recourse and Non-recourse Factoring
This difference does not lie exclusively in the area of financing, meaning rates, fees and funding promptness, but mainly relates to the qualification requirements to the parties involved.
The distinguishing feature of such factoring is that the risk remains with an owner-operator or a freight carrier, not a factor.
Nevertheless, recourse factoring has a range of advantages. By choosing this kind of financial service, you will get these bonuses:
- Get payment of up to 99.0% from the invoice amount on your account right after the fact of delivery is confirmed documentarily;
- Pay fewer factoring fees, up to 0.5-7% on average;
- As a rule, the application for recourse factoring is considered quickly, since there is no need to fully verify the solvency of the debtor as in the case of non-recourse factoring;
- Minimum paperwork;
- You will cover your cash gaps easily;
- Increase the volume of services provided by timely financing of working assets;
- Increase the competitiveness of the business due to the ability to provide the counterparty with the deferred payment they need;
- Get more favorable commission fees.
Application of this factoring type is one the major steps to run a freight trucking business safely. The factoring company carefully checks your client to know with whom it will deal. So, this could become a perfect financial tool for a transport company for many reasons:
- You will surely receive money from a factor, although the factoring rate will be less than with recourse factoring: usually around 70% upon receipt of invoice for delivery and the rest after full return of the debt;
- Factoring fees will be higher, because a factoring company needs compensation for any possible risks and incremental costs, but not by much;
- No risk of late or incomplete payment of the delivery by the payer;
- Due to the timely receipt of money, you can attract new customers, expand the range of services and, as a result, increase turnover and profit;
- Reduction in administrative costs, since specialists working with receivables are not required.
When this option is applied the factoring company needs to avoid any risk of non-payment. You receive the needed amount, regardless of the financial ability or inability of the debtor to settle a transaction. In addition, the factoring company undertakes all work related to management, including the collection of overdue receivables from the payer.
That was a short presentation of the difference between recourse and non-recourse factoring.
How to Use Factoring for Cash Flow?
You sell invoices to a factoring company and get cash immediately, while the company does all the waiting. Just think of all the opportunities that gives you:
- Money can be used to pay salaries to drivers;
- Buy fuel or spare parts for truck repairs;
- Upgrade the fleet, purchase modern equipment;
- Invest in business expansion, its advertising and promotion.
If you choose the right type of factoring for this particular delivery with this particular client, and manage to get the most favorable conditions from a factoring company. That will help to ensure you have enough cash flow for all your expenditures and even expansion of your business.
Choosing Between Recourse or Non-recourse Factoring
To sum up, factoring can be an effective, although sometimes risky, solution. It is up to you to decide whether to use one of the two. The difference between recourse factoring and non-recourse factoring was presented above in this article.
Recourse option is suitable if:
- Your company works with proven and reliable customers, for example, on an ongoing basis;
- You need to get the service quickly, without wasting time waiting for the factor to check the customer;
- The amount of factoring fees and rates is essential.
Non-recourse option will be your choice if:
- The company is not sure about the customer;
- There is no time and means to control the payments and chase up debts.
So, plan ahead and weigh up the advantages and disadvantages of each option, and if you are a newcomer to this market there are companies with extensive experience and skills to help you. Such is, for example, HMD Financial, one of the members of the HMD company group family, being the undisputed leader of the trucking business in the US.