Recourse in Invoice Finance: a Worked Example

A financier that advances money against an invoice has two possible sources of repayment: the customer who owes the invoice and the client who raised it. Recourse is the right to go to the second when the first has not paid. It is why a recourse facility can be priced as lending to a business with a spread of debtors behind it, and not as a purchase of each debtor's credit.

The right is only as good as the client on the day it is used. A customer that fails in a downturn tends to fail alongside others, and the client is then asked to refund advances when its own cash is shortest. The same idea appears in trade finance. A bank that discounts a letter of credit with recourse can claim the advance back from the exporter if the paying bank does not pay at maturity. Without recourse, the discounting bank looks only to the paying bank, and the risk sits against its limit on that bank rather than on the exporter.

The agreement sets a period after which an unpaid invoice stops being funded, and many also let the financier recourse a debt at once if the customer becomes insolvent. The invoice is then taken out of the eligible ledger. In practice the client seldom writes a cheque: the advance is recovered by lowering what the client can draw.

A non-recourse facility moves less than its name suggests. The cover usually applies to customers the financier has approved, up to a credit limit for each, and for inability to pay. A customer that refuses an invoice because the goods were wrong or the work incomplete has raised a dispute, not a credit loss, and that risk commonly stays with the client under either kind of facility. Providers often place trade credit insurance behind the promise, and the insurer's conditions then shape what the client receives.

A freight forwarder, constructed for this page like every figure in it, invoices US$40m a year and has a debtor ledger of US$5.0m. It compares two offers. The recourse facility advances 85%, charges a service fee of 0.50% of invoiced sales, and hands back invoices at 90 days or on the customer's insolvency. The non-recourse facility advances 80%, charges 0.90%, and bears 90% of the loss if an approved customer becomes insolvent. All of these terms are the example's and are not a market norm. Interest is left out because it follows the money drawn.

Now one approved customer goes into liquidation owing US$400,000, all of it undisputed and within its credit limit. Any later dividend from the liquidation is ignored.

Under recourse the forwarder loses US$400,000 and must find US$340,000 of it immediately, in the same week its carriers still expect to be paid for moving that customer's freight. Under non-recourse it loses US$40,000, having paid US$160,000 more in fees that year and started with US$250,000 less funding. Neither answer is correct in general. The comparison turns on how large the forwarder's biggest customers are against its own cash, and on whether a loss on that scale would end the business.

The word has a second use that catches readers. On a project or property loan, non-recourse or limited-recourse means the lender may look only to the financed asset and its income, and has no claim, or only a limited one, on the owners behind it. In receivables finance the party who would be pursued is the client that raised the invoice. The two ideas share a word and little else. A guarantee is a third thing again: a separate promise from someone outside the facility, which many invoice financiers take alongside recourse.

Accounting can blur the picture too. Under the Australian and New Zealand versions of the international standard, an entity that keeps substantially all the risks and rewards of a transferred receivable goes on recognising it and books a liability for the cash received. UK companies on FRS 102 apply their own derecognition test in section 11, also built on risks and rewards. Where a transfer has been treated as a sale, any recourse left behind may be carried as a small liability or sit in the notes among the contingent liabilities, and a lender reading them adds it back.

DEFINED IN ONE PARAGRAPH → · PRODUCT FILE: INVOICE FINANCE → · THE AGED DEBTORS REPORT →

A lender reading a business that uses recourse finance treats the funded balance as borrowing whatever the accounts call it, and reads the aged debtors as a schedule of possible cash calls: every invoice approaching its recourse date is an advance that may have to be returned. A rising count of recoursed invoices is an early sign that collections are slipping, and it arrives before the accounts show it.

On the financier's side the question is whether the two sources of repayment are really separate. A client that sells most of its output to one failing customer offers recourse that disappears with the customer. That is why recourse sits beside concentration limits and eligibility tests, and does not replace them.

PRODUCT FILE: LC DISCOUNTING → · CONCENTRATION LIMITS →