What it means
Businesses sometimes sell their unpaid invoices to a finance company, called a factor, to get cash quickly instead of waiting 30 to 90 days. The key question is who bears the loss if a customer fails to pay.
In a non-recourse sale, the buyer does. This makes the arrangement a true sale for accounting purposes, because the risks and rewards of the receivable pass to the buyer.
The seller can usually remove the invoice from its balance sheet, which can improve its liquidity and certain ratios. In a recourse sale, by contrast, the seller must make good any unpaid amount and the receivable stays on the books.
Buyers price this protection into the deal. They check the creditworthiness of the customers, often set credit limits on each, and charge higher fees than for recourse factoring.
They may also refuse to cover certain risks, such as disputes over quality or delivery, which stay with the seller. Non-recourse sales are widely used in trade and export finance, where selling to customers abroad creates unfamiliar credit risks.
They are also used outside invoices, for example when a bank sells a pool of loans to investors with no promise to repay if the borrowers default. The main trade-off is cost against certainty.
The seller pays a higher price to remove the risk of bad debts and gains predictable cash flow, while the buyer earns a fee for taking that risk. Businesses with a few large customers often value this protection most.
Contracts should be read carefully, because the term non-recourse is often limited to a customer's inability to pay. A dispute about the goods will usually still be the seller's problem, and any breach of the sale terms can bring the recourse back.
In practice
Real-world examples.
Example
An exporter of furniture sells $400,000 of invoices to a trade finance company without recourse. When one overseas buyer becomes insolvent, the loss falls on the finance company and the exporter keeps the cash already received.
Example
A bank packages $50,000,000 of car loans and sells them to investors with no promise to cover defaults. The bank removes the loans from its books and frees up capital to lend again.
Example
A staffing agency sells its $120,000 of monthly invoices on a non-recourse basis so that it can pay wages on time. The agency keeps the factor's fee as a known cost and does not need to hold a bad-debt reserve for those invoices.
Formula
Calculation
Cash to seller = Invoice value x Advance rate - Fees
A manufacturer sells $200,000 of invoices to a factor on a non-recourse basis. The factor advances 85% and charges a fee of 2.5% of the invoice value. Advance = $200,000 x 0.85 = $170,000, and fee = $200,000 x 0.025 = $5,000, so the cash to the seller now is $170,000 - $5,000 = $165,000. If the customer later fails to pay a $30,000 invoice within the pool, the factor absorbs the loss and the manufacturer owes nothing back. The factor keeps the loss because it chose to take the credit risk when it bought the invoices.Case study
Seen in the real world.
Kestrel Textiles is a fictional clothing supplier invented to illustrate this idea. It sold goods on 60-day terms to a handful of large retailers and worried that one failure could cripple its cash flow.
The finance director sold $500,000 of invoices to a factor on a non-recourse basis, receiving 80%, or $400,000, up front. Three months later one retailer entered administration owing $90,000 on the sold invoices.
Because the sale was non-recourse, the factor absorbed that loss, and Kestrel's results were unaffected. The director noted that the fee had been higher than for a recourse deal, but she judged the certainty to be worth it, and she added a credit check before accepting new customers. She also asked the factor to share its credit ratings on each retailer, which gave Kestrel an early warning on weaker buyers.
Watch out
Common mistakes.
- Assuming non-recourse covers every dispute. It usually covers customer insolvency or non-payment, not quarrels about quality or delivery.
- Choosing the cheapest quote without comparing recourse terms. Lower fees often mean you carry the bad-debt risk.
- Forgetting to follow the contract's conditions. Breaching a warranty in the sale agreement can bring recourse back into play.
Questions
People also ask.
Does a non-recourse sale remove the debt from my balance sheet?
Usually yes, if the risks and rewards pass to the buyer, though accounting rules look at the substance of the deal.
How is it different from a recourse sale?
With recourse, the seller must repay or replace unpaid items, and with non-recourse the buyer takes that loss.
Who sets the credit limits?
The buyer normally approves the customers and sets limits, since it is taking the credit risk.
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