Glossary of Factoring Terms
Understanding the language of factoring can help you to conclude when to use this powerful form of financing for your business growth and who to partner with to implement it.
Account Debtor – Refers to the customer of a factor’s client or the company that actually owes the money due on the invoice(s).
Accounts Receivable – Monies due for products or services that have been already delivered due at a specific time in the future. Typically these refer to Business to Business transactions. Also referred to as Trade Credit or sales on Open Account Terms. These funds are considered a liquid asset on the balance sheet and are generally expected to be paid in less than ninety days.
Accounts Receivable Financing – Refers to a financing strategy for securing working capital in the short-term. The factor advances monies to the business as a form of loan that is collateralized by a security interest in that company’s accounts receivables. Loan amounts are determined as a percentage of the accounts receivables amount pledged.
Advance Rate – The money advanced to the client by the factor following invoice presentation and before actual collection of funds from the customer. Advances are calculated as a percentage of the total face value of the invoice and usually range between 70 to 90%.
Asset Based Lending – A form of business loan where the borrower pledges collateral, such as accounts receivable, equipment and inventory, to a lender as additional repayment security against monies advanced.
Charge Back – An amount of money owed to the factor or “charged back” to the client when the factor is unable to collect the Account Receivable that was factored, based on an agreed upon debtor non-payment clause in the Factoring contract. The factor will typically take this out of a reserve release or an advance.
Credit – The extending of time in relation to when payment is required in return for product or services provided.
Credit Analysis – The process of analyzing the records and financial affairs of a business to determine creditworthiness.
Creditor – Refers to the party or business, to whom money is owed.
Customer – Also referred to as the account debtor, this is the party to whom the original products or services were provided and to whom the factor shall then collect monies from under the terms and conditions of the factored invoice.
Dilution – The amount of risk associated with collection of the accounts receivable including but not limited to returns, charge-backs, trade allowances, concentrations, slow pay, and bad debt.
Due Diligence – When a factor conducts a background check and research to assess the creditworthiness and validity of a prospective factoring client as well as that client’s customers.
Factor – The agent and/or organization that purchases a businesses accounts receivables and assumes collection of associated invoices from applicable clients.
Factoring – The selling of a businesses accounts receivable to a third party at a discount, for the purpose of obtaining funding.
Factors Acknowledgment Form – A form used by factors to send to their client’s customers, which verifies that the client’s invoice does exist and that the customer will remit payment due under that invoice to the factor.
Factors Client – Refers to the business that is selling its accounts receivable to a factoring agent or organization.
Factors Fee – Refers to the fee the factor charges for providing advance funding of the client’s accounts receivables amount.
Factors Services – Services provided by the factoring agent to the client on behalf of the factoring process, such as credit analysis, credit guarantees and collection management.
Factors Verification – Refers to the process whereby a factor verifies that the goods and services represented as provided and invoiced by the client to the customer, were in fact provided and accepted, and that the customer intends to pay the factor the money due under the invoice. This process is performed and satisfied prior to making the advance payment to the client against the invoiced amount.
Full Recourse Factoring – In this type of factoring, the factor is protected against customer non-payment. If the customer does not ultimately pay the invoice, the client is responsible for paying back the funds advanced.
Non-Notification – In this type of factoring, the customer or account debtor is unaware of the factor purchasing the client invoice. They are however, directed to make payment to a lock box controlled by the factor. Any contact that the factor makes is made under the client company name.
Non-Recourse Factoring – In this type of factoring, the risk of customer repayment is assumed by the factor. Factoring fees are often higher for this form of factoring and the client is still responsible for performance-related responsibilities relative to the quality of the products and/or services provided.
Purchase Order Financing – Refers to the assignment of purchase orders to a third party who then assumes the obligation of billing and collecting. Typically, this form of financing is tied to a specific transaction where the company requires cash to be able to acquire the raw materials to manufacture the goods for which it has received the purchase order. Because the third party assumes both the production risk and the collection risk, this form of financing can be costly.
Reserve – Refers to the amount withheld by the factor net of the advance. Can be used as a financial cushion to protect against shortages, disputes between the client and the customer or bad debt losses due to customer non-payment. The reserve should be released to the client after the customer has paid the factor the total money due on the invoice.
Reserve Release – The process of the factor releasing final monies due the client once the invoice has been totally satisfied less any applicable fees or charge-backs.
PPSR (Personal Property Security Registry) – A Financing Statement (General Security Agreement) is filed to perfect a security interest in named collateral and establishes priority in case of debtor default or bankruptcy. PPSA (Personal Property Security Act) refers to the collection of laws dealing with commercial business.
Working Capital – The amount of money that a business has available to conduct it’s day-to-day activities. It includes monies that that the owner or investors have invested in the company, retained earnings and supplier credit. A business with limited working capital benefits from factoring by eliminating the time that invoices are outstanding (see Financing Spreadsheet Tool).