Association for Financial Professionals (AFP) Practice Exam

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What does the term "no recourse" mean in a factoring agreement?

Seller has a guarantee on all debts
Factor absorbs the loss if a customer fails to pay
Sellers are responsible for all customer debts
Factors only buy accounts with strong credit ratings

The correct answer is: Factor absorbs the loss if a customer fails to pay

In a factoring agreement, the term "no recourse" refers to the situation where the factor assumes the risk of non-payment by the customer. When an agreement is described as having "no recourse," it indicates that the factor will absorb the loss if the customer fails to satisfy the debt. This shifts the financial risk from the seller (the business selling its receivables) to the factor, meaning the seller is not liable for unpaid invoices once the factor has purchased them. This arrangement is appealing to sellers because it allows them to receive immediate cash flow without the worry of potential defaults by their customers. In contrast, a recourse agreement would mean that if the customer did not pay, the seller would have to buy back the unpaid receivables from the factor. By having no recourse, the seller can better manage financial risk, providing greater peace of mind as they seek to maintain consistent operations.