Common Terminology Used in Factoring
Invoice factoring is a widely-used form of working capital financing. Like all forms of financing it uses terminology, and this terminology has specific meaning when used in a factoring context.
If a client of yours is thinking of using factoring to increase their working capital and accelerate their cash flow, it will be easier for the client to understand the terms of the factoring agreement if the client knows the meaning of factoring terminology.
The following list of commonly used factoring terminology will help clients be more comfortable when they discuss a factoring agreement with factoring brokers and factor personnel.
Invoice Factoring: A form of debtor financing that businesses use to accelerate cash flow by selling their invoices to a third party (factor) at a discount. Businesses receive cash immediately for their unpaid invoices instead of waiting for their customers to pay.
Advance Rate: This is the percentage of the invoice amount that will be advanced. The percentage depends on certain criteria including the client’s customers’ credit quality and financial condition. The advance rate percentage is generally around 70% – 80% of the gross invoice amount.
Advance: This is the amount of money that the factoring company advances to a client when it buys an invoice.
Account Debtor: A client’s customer. This is the business that owes payment on a client’s invoice.
Customer Credit Limit: The maximum amount of credit applicable to a specific Account Debtor. A client may be unable to receive an advance against an invoice if their customer’s credit limit has been reached.
Factoring Fee: The fee the factor charges to factor a client’s invoices. The fee is expressed as a percentage charged on the face value of the invoice.
Funding Period: This is the time period that begins when the factor purchases an invoice and ends when the Account Debtor pays the invoice.
Rebate: The invoice balance, less fees, that is deposited into a client’s account when the invoice is paid.
Factoring Agreement: The agreement between a client and the factor. It will cover all aspects of the program including fees, advance rates, credit limits, and other details.
Due Diligence: This is a review of a client’s and a customer’s financial backgrounds to determine eligibility for factoring.
Recourse Factoring: The client is responsible for paying the invoice if their customer fails to pay the factor.
Non-Recourse Factoring: The factor absorbs any credit losses that result from an Account Debtor not paying an invoice. Fees for non-recourse factoring are generally higher than recourse factoring, and credit limits may be lower.
Client: This is the business owner that wants to sell its invoices.
Notice of Assignment: A notice that is sent to an Account Debtor informing them that the invoice has been assigned to a factor. It also informs the customer of the new address for payment.
Aging Report: A report that shows how long accounts receivable have remained outstanding.
Credit Terms: These are the terms of payment that appear on your invoice, such as Net 30 Days or Net 60 Days, which is payment due by 30 or 60 days after the invoice date.
Collections: These are payments the factor receives for invoices that were factored.
Lockbox: A bank cash management system designed to receive payments by mail and quickly deposit them into the factor’s account. Lockbox systems usually provide scanning of documents, online viewing and cash management systems.
Bad Debt: A bad debt is the unpaid balance of an invoice that is deemed to be uncollectible. A bad debt is either written off or referred to a collection agency or lawyer.
Credit Insurance: An insurance policy that covers the potential loss due to non-payment of an invoice.
The following table compares lending terminology with factoring terminology to make it easier to understand the context that factoring terminology is used in.
Understanding factoring terminology will help your clients ask the appropriate questions when deciding which factoring company to work with and if factoring is the right solutions for their needs. Factoring can provide the additional working capital clients will need to finance the business opportunities that will arise in 2022 as the economy continues to grow. Capstone has the experience and capability to tailor a factoring program to meet your client’s working capital needs.