Updated: Jan 5
Factoring Companies, Trade Credit Insurance and Debt Collectors each provide unique services to help businesses get paid for work that has been completed. But you may be a bit confused about the difference between them, how they are related – and how they’re different.
This article will explain the basics to help you understand the differences and what may be suitable to protect your accounts receivable and make sure you get paid for your work and services.
A factoring company gives you a way to get working capital for your business by using your outstanding invoices as collateral.
A factoring company will buy your invoices at a reduced amount of the face value of the invoices. The factor provides a cash advance ranging from 70% to 90% of the invoice’s value, and when the invoice is collected, the factor will return the remaining balance of the invoice minus their fee. These costs may range from 1% to 10%, based upon various components.
Factoring Usually Does Not Protect You From The Risk Of Non Payment
The big difference between trade credit insurance and factoring is that factoring is not necessarily a way to protect your company from the risk of nonpayment. This is because most factoring companies are “recourse factors.”
Recourse vs. Non-Recourse Factoring
There are two types of invoice factoring: recourse and non-recourse. Before you choose to do business with a factoring company, it is important to know the difference between the two options.
A recourse factor agreement states that, once the terms of the initial invoice have eclipsed and the debtor refuses to pay, you must purchase that invoice back from the company – and you must continue pursuing the debt on your own.
It is very rare to work with a company that does not use recourse factors. Those who offer Non-recourse factoring typically charge an extremely high fee – and they only pay for the bad debt if it’s caused by bankruptcy. If the client simply refuses to pay or disappears, you still have to buy back their invoice from the factoring company.
Essentially, you cannot hope to get rid of bad debt by offloading it onto a factoring company.
By using a factoring company, you can access the money you’re owed more quickly and use it for operations and other business needs. Just don’t think that you’ll be able to “dump” bad debt with invoice factoring – The use of “recourse factors” means that this is simply not possible.
Trade Credit Insurance (TCI)
The primary function of trade credit insurance is to protect sellers against buyers that do not or cannot pay.
Your trade credit insurance policy will pay out a percentage of the outstanding debt if a buyer does not pay. This percentage usually ranges from 75% to 95% of the invoice but may be higher or lower depending on your coverage plan.
Trade credit insurance policies are usually flexible and allow the policyholder to cover the entire portfolio or just key accounts. The most common type of coverage is “Whole Turnover,” which covers all buyers of the policyholder.
What risks does trade credit insurance cover?
Trade credit insurance covers defaults resulting from customer insolvencies, as well as bankruptcy and other nonpayment risks.
What’s not covered by a trade credit insurance policy?
The risk being transferred has to connect directly to an underlying trade transaction. If no direct trade link exists, outstanding debts cannot be covered by a trade credit insurance policy.
Is Accounts Receivable/Trade Credit Insurance Worth the Cost?
Premium rates for Trade Credit Insurance are generally based on the sector and geographies you work in, losses experienced in the past, customers you trade with, and many others.
However, while Factoring and Trade Credit Insurance can be beneficial in the short term, there are long-term costs to consider. You pay fees ranging from 1% to 5% for the service, even if the invoice is paid in full within 60-90 days. The longer the receivable remains unpaid, the higher the fees. Payment guarantees aren’t always available, and if they are, they can double factoring fees to as high as 10%. For small businesses with smaller receivables, this may not seem like a lot. For larger companies, there is the potential to lose between $10,000 to $100,000 for every $1 million in receivables.
No matter what measures you take ahead of time, it’s possible – even likely – that at some point, you will have a non-paying client. For example, let’s say you’ve mailed the initial invoice, sent a couple of follow-up invoices, e-mailed and left one or more voicemails, all with no resolution. What else can you do?
At this point, most businesses will turn to a collection agency, handing over the hassle of collecting in exchange for a fee or percentage of the debt. A Debt collector as Fair Capital is a third-party agency that will deploy a proven diplomatic and strategic combination of multiple components designed to persuade your debtor to honor their obligations.