Factoring or invoice discounting: who carries the risk

The three variables

Strip away the terminology and every receivables arrangement is defined by three answers.

• Who collects? Under most factoring, the debt is assigned to the factor, who collects from your customer directly. Under most invoice discounting, you continue to collect and remit.
• Does the customer know? A disclosed arrangement notifies your buyer that the debt has been assigned. An undisclosed one does not, and the buyer continues to deal only with you.
• Who loses if the customer does not pay? This is recourse, and it is the one that determines the price.

Recourse and non-recourse

With recourse, the financier advances against the invoice, but if the buyer fails to pay by an agreed point, the financier recovers from you. You have obtained funding, not protection. The advance is effectively a secured short-term borrowing, and it is priced as one.

Without recourse, the financier absorbs the loss on an approved buyer's insolvency or protracted default. You have obtained funding and credit protection. It costs more, and the financier will be selective — approving specific buyers, setting limits per buyer, and often declining the ones you are most worried about.

That selectiveness is the point people miss. Non-recourse does not remove credit risk from your business generally; it removes it on the buyers the financier was willing to approve, which are usually the buyers least likely to default.

What disclosure costs you commercially

Disclosed factoring means your customer receives notice that the receivable has been assigned and pays the factor directly. Operationally this is efficient and it removes collection effort from you.

Commercially it is not neutral. Some buyers read a supplier factoring its receivables as a sign of cash strain, and in sectors where relationships are long and negotiated, that perception has a cost. Others regard it as entirely routine. Whether it matters depends on your market, and it is worth an honest assessment rather than an assumption in either direction.

Undisclosed arrangements preserve the relationship as it was, at the cost of leaving collection and its administration with you.

How to price the choice

Compare non-recourse against the alternative of taking recourse funding and separately insuring the credit risk. Those are two routes to the same outcome and they do not always cost the same.

Work out, for each route, the all-in annualised cost over the days funded: discount or interest charge, service or administration fee, per-invoice charges, and on the insurance route the premium and the retained portion of any loss. Then check what is actually covered — approved buyers only, limits per buyer, the definition of default, and the waiting period before a claim pays.

A non-recourse facility covering only your three strongest buyers may be worth less than it appears. A credit insurance policy with a broad approved list may be worth more.

Which problem are you solving

The honest starting question is not which product is cheaper, but which problem you have.

If the issue is purely timing — solid customers who pay reliably but slowly — recourse invoice discounting or a CC/OD is usually the cheaper answer, and paying for credit protection you do not need is waste.

If the issue is concentration — a large share of your book owed by one or two customers whose failure would take the business with it — then the credit protection is the product and the funding is incidental. Price it on that basis.