Understanding Accounts Receivable Factoring Agreement

Accounts receivable factoring is a crucial financial strategy to fund your business' daily operations when your customers are unable to pay up on time and you don't have sufficient reserve of working capital. In a sense, it is understood as a special loan-like instrument available from specialized agencies, known as factoring companies, or just 'factors'.
Like bank loans, there is an application process and paperwork involved - some of which is legally binding. There can be several types of factoring agreements as discussed under.
The accounts receivable factoring agreement is a contractual, legal agreement that generally lasts a year. Some factoring companies contract for only six months followed by extensions, and then there is a few that contracts on a monthly basis. Note that shorter the contractual period, higher is the fee payable. As the contractual agreement is for a long-term, it is imperative that the finer aspects of factoring agreement are understood thoroughly.
Factoring agreements
It can be of two types - with, or without, recourse.
In with-recourse option, you can avail working capital from the factoring company without any transfer of risk to the factor. In other words, if your customer fails to pay up, you need to repay the entire sum to the factor out of your own margins. In the without-recourse option, you may avail funds while simultaneously transferring the risk to the factoring company. This means that if your customer fails to pay up, the factoring company cannot ask you to repay the availed funds - in short, the factoring company bears such loss. Note that because of the high risk involved, the fee levied is also higher.
Study your and your customers' business situation thoroughly before you decide to go for business factoring. Once you are thorough on this, find out which type of factoring would best serve your needs. One option is inexpensive but doesn't bear the risk; other bears the risk but has high costs.
Costs of factoring
There is a fee levied for business factoring, known as a factoring fee. This fee is generally made of several components like an initial fee to set up your factoring account and process your application, a variable payment that varies with the volume of transactions and an interest rate, also known as the discount rate that is applicable on every transaction.
Interest rates may be revised in case your customer does not pay up even after requested timeline. There may be one or more clauses that shield the factoring company from default payments and fraud by customer, if any.