Demystifying Factoring Terminology: A Guide for Business Owners

Asset-Based Finance is pretty much exactly what it sounds like, a method of financing based on the assets of a business.  In the vast majority of instances, however, asset-based finance will involve only the “primary” assets found in almost any business entity.  Primary assets include:

  • accounts receivable
  • inventory
  • equipment

Real estate, also an often found business asset, is usually excluded in discussions of asset-based finance since real property is more typically financed in a separate transaction utilizing long-term amortized loan structures.

Asset-based finance often tends to deal with the financing complexities associated with collaterals which are dynamic and whose value and location can change rapidly.  An example would be business inventory, which is constantly being decreased as sales are produced and increased as replacement goods are purchased or manufactured.  Real estate, on the other hand, tends to be more static in nature and an asset whose value (and location) is always easy to ascertain and monitor by the lender.

Important Factoring Terminology

All industries tend to have a certain amount of industry-specific jargon associated with day-to-day operations and the factoring industry is no different.  To follow are some basic (but important) terms you should become very familiar with as an industry broker.

  • ADVANCE: an initial disbursement of funds by a factor to the seller upon purchased invoices.  (Typically 80 percent)
  • ACCOUNT: an account receivable or simply, an invoice
  • ACCOUNT DEBTOR: another name for the customer or the party obligated to make payment upon an account (invoice).  When you refer a client to a factor, that client will have customers.
  • AGING REPORT:  An accounts receivable aging report is a report generating by a client’s accounting software (such as QuickBooks) which lists the invoices currently outstanding and how long they have been outstanding.
  • ASSIGNMENT: the assignment of ownership to a factor of the invoices and rights involving such invoices such as rights to collect upon those invoices.
  • CLIENT: the business that is selling its invoices to a factor.  As a broker / referrer, you will refer clients to factors and lenders
  • CUSTOMER: a more common term for the account debtor obligated to make payment on an invoice
  • DISCOUNT: the fee amount charged over the period an account is outstanding for the factor’s service
    (the “Factoring Fee”)
  • NON-RECOURSE: a factoring arrangement in which the factor assumes the non-payment risks associated with the bankruptcy or insolvency of a customer while an invoice remains unpaid
  • NOTIFICATION of ASSIGNMENT: a notice sent to an account debtor (customer) regarding the assignment of ownership in the accounts of a business and rights to payment upon those accounts.  Once a customer receives the factor’s notification of assignment, that customer is then obligated to make payment to the factor and no longer the client (seller of the invoice).
  • RECOURSE: a factoring arrangement where the factor has the right to charge-back purchased invoice amounts to the client if payment is not received from the account debtor within a specific period of time (usually 90 days)
  • RESERVE: the percentage of the face value of an invoice not advanced and used to secure the factor against trade disputes, reduced invoice payment, or non-payment
  • RESERVE DISTRIBUTION: commonly called a “rebate”, is the periodic payment to the client of the excess reserve held by the factor.  If a factor advances 80% of an invoice face amount, ultimately the factor will hopefully receive a 100% of the invoice face amount.  The 20% leftover is reserve and will be distributed to the client after the factor’s fee (which includes your commission) is taken out.

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