For someone who hasn't worked with factoring before, there is a lot of terminology that may be new or confusing. While factoring is a fairly simple and straight forward form of financing, understanding the terminology associated with it is crucial to understanding how factoring works. Not all factoring companies are the same, with different factoring companies having different policies and requirements. Understanding factoring terminology will help you in asking appropriate questions when starting a factoring relationship, and ensure that you choose the correct factoring company to work with. Here we will highlight some common terminology in the world of factoring and finance to help clear up some of that confusion.
Accounts payable is money owed by a company to its suppliers for goods or services received. It can also refer to the department that makes payments on these debts.
Accounts receivable is money that is owed to a company in exchange for goods or services they provided to their customer. It can also refer to the department that is in charge of managing and collecting the receivables.
Accounts receivable factoring is simply another name for factoring, the process of selling your receivables to a factoring company.
Accounts receivable financing is simply another name for factoring, the process of selling your receivables to a factoring company.
Advance refers to the funds received from your factoring company for the purchase of receivables that are not yet due.
The advance rate is the percent that a factoring company advances you on an invoice. Typically advance rates are in the range of 80-90%, because factoring companies hold back funds in reserve which become payable once they receive payment for the invoice.
An aging statement is a report showing all of your outstanding receivables categorized into "aging" buckets of 30 days.
When you factor a receivable, you are assigning it to your factoring company. That means that the customer needs to remit payment to the factoring company and not to the vendor.
A Bill of Lading, often abbreviated as BOL, is a detailed receipt provided by a freight company to the consigner of the items being shipped.
Cash flow is the amount of money moving into and out of a business. It is important for a company to have positive cash flow, meaning more money coming in, in order to sustain operations. Waiting 30 days or more to get paid on receivables can be a major impediment to a company's cash flow.
Collections is the process of getting paid from account debtors once an invoice becomes due. It can also refer to sending an extremely past due to a collection agency.
In order to factor an invoice, the factoring company must first provide you with a credit approval. To do this a factoring company will check out the credit worthiness of a customer and determine an appropriate credit limit for them. A credit approval should be requested after receiving a PO, and before work begins on production of the order.
Credit insurance is a form of insurance that protects you against customers who do not pay for financial reasons. In the case that a customer goes bankrupt, out of business, or simply will not pay, the insurance company will pay you for the receivable.
A credit limit is the maximum amount of credit that a factoring company is willing to extend to an account. It is very likely that factoring companies may work with a handful of vendors who all sell to the same account, in this situation some factoring companies will assign an individual limit for each vendor, while others will assign a cumulative limit. If your factoring company assigns a cumulative limit and they have receivables out with other vendors, it is possible that you will not see a credit approval for the account as their credit limit may already be used up.
In situations where a factoring company is unable to find any information on account, or an account doesn't have enough credit to justify a high enough credit limit, a factoring company may request credit references. These references can then be used to establish a credit limit and give a credit approval. It is important to note however that if a vendor must offer the account payment terms in order for it to be a valid reference.
Discount is another term for the factoring fee in exchange for factoring services, typically it is a percent of the receivable.
Factoring is the process in which a supplier sells their receivables to a factoring company at a discount in exchange for getting paid prior to the receivables becoming due. Typically, with factoring the supplier is also outsourcing the management of their receivables, including credit checking and collections, and receiving credit insurance on factored receivables.
The factoring fee, or discount, is the rate that a factoring company charges their clients to factor an invoice. It is typically a percent of an invoice's value. The factoring fee may not be the only charge associated with factoring an invoice, some factoring companies also charge their clients interest on top of the factoring fee.
Fintech is short for "Financial Technology". These are firms that offer internet based financial services ranging from accounting, to loans, to factoring. Typically, it is considered to be disruptive towards traditional financial firms.
FOB means that ownership of the product is transferred from the seller to buyer and the payment terms begin when the product is placed on board a vessel, typically a container ship, in its country of origin.
An intercreditor agreement is an agreement between two lenders where the senior lender subordinates some of their collateral to the junior lender. In a case where a company already has a loan from a bank that places a lien on their receivables, the bank would need to subordinate that lien to a factoring company in order for the factoring company to be able to purchase receivables.
Factoring companies have the right to charge interest. Depending on the factoring company, the interest may be charged either to the vendor or to their customer. In general, factoring companies that charge interest to the customer only due so when an invoice is paid beyond terms, plus they typically offer a very generous grace period before interest is charged. Factoring companies that charge interest to the vendor may start charging interest either at the time of the advance or when payment becomes due, they do not typically offer any grace period and may tack on additional days to allow for a payment to clear.
An invoice is a bill sent to a customer that itemizes goods or services provided. It should specify who the billing party is, where to remit payment to, and when payment is due.
Invoice factoring is simply another name for factoring, the process of selling your receivables to a factoring company.
A letter of assignment is a letter sent out to a vendor's accounts informing them of the vendor's relationship with a factoring company. The primary purpose of the letter is to instruct the accounts to remit payments to the factoring company going forward.
A line of credit is typically something that comes from a bank, although other financial institutions offer lines as well. Unlike a loan which has a fixed term and once paid off is closed, a line of credit can be drawn upon and paid down numerous times throughout its term. However, a line of credit will have collateral tied to it at all times, even when it is not being drawn upon, and therefore having an open line of credit may prevent you from being able to factor without an intercreditor agreement.
Micro factoring is the same as factoring, but is specifically for companies whose annual volume is less than a certain threshold, typically $100,000.
Some factoring companies have minimum volume requirements. This requires a supplier to factor a fixed amount of receivables each year. If this fixed amount is not met, the factoring company will fine the supplier an amount equal to what the factoring fees would have been on the shortfall.
Net terms, also called payment terms, refers to the period of time that a customer has to pay for an invoice. If terms are net 30, then payment is due 30 days after the invoice date.
Non-recourse means that if a debtor does not pay for a factored invoice, the supplier does not have to repay the factoring company. In other words, non-recourse factoring refers to factoring that incudes credit insurance.
Payment terms, also called net terms, refers to the period of time that a customer has to pay for an invoice. If terms are net 30, then payment is due 30 days after the invoice date.
Pledging receivables means that your receivables are being used as collateral for either a loan or line of credit. Typically, the receivables are pledged to a bank or financial institution, but in some instances they could also be pledged to an investor. If your receivables are pledged, you will be unable to factor without an intercreditor agreement.
A proof of delivery, often abbreviated as POD, is a document signed by a recipient of goods that proves that they have been delivered.
A purchase order, or PO, is a document sent from buyer to a supplier stating that the buyer agrees to purchase and pay for the products and services mentioned on the PO. The PO will also state the dates that the products or services are needed, and the terms under which payment will be made.
Purchase order financing, or PO financing, is a short term loan to a supplier based on a purchase order they received from a customer. The loan is given so that the supplier has the necessary funds to produce the order.
Short for accounts receivable, this is the money that id owed to a company in exchange for goods or services provided to their customers.
Recourse means that if a debtor does not pay for a factored invoice, the supplier is responsible for repaying the factoring company. In other words, recourse factoring refers to factoring without credit insurance.
Some factoring companies offer contracts that have a fixed term, typically one year, and automatically renew each year. Oftentimes if you wish to get out of the contract you need to notify them several months in advance. It is also possible that they could charge a renewal fee, even in the case where renewal is automatic.
Factoring companies hold back money in reserve so that they are covered in the situation where a customer takes a deduction on an invoice, it is calculated as a percent of the invoice's value. Reserve is actually a receivable that the factor owes to their client and is payable once the factor receives payment for an invoice.
Reverse factoring is similar to supply chain finance. It is when a financial institution agrees to pay a customer's receivables early and at a discount, in exchange for the customer agreeing to remit the full amount to the financial institution when the receivable becomes due. Like supply chain finance, this solution needs to be implemented by the customer, and it is up to the vendor whether or not they wish to accept it.
Spot factoring is the same as factoring, but refers to when a company only wants to factor a single invoice or a single account.
Supply chain finance is when an account offers to pay a vendor early in exchange for a discount. While it accomplishes the same goal as factoring, improving a vendor's cash flow, it does not mitigate risk and it is initiated by the customer only if they wish to offer it. A vendor does not have to accept early payment at a discount if they do not wish to do so.
UCC stands for uniform commercial code and refers to a set of laws pertaining to business financing transactions. A factoring company needs to file a UCC against a client so that they have the right to purchase their receivables. In the case where a client has an existing loan or line of credit and receivables are used as collateral, a factoring company will need to have an intercreditor agreement with the other lender.
Working capital is the money available to a business to meet their financial obligations. It is calculated as a company's assets minus their liabilities.
Certainly there is a lot of terminology involved in the world of factoring, but luckily you won't be getting tested on it. If you do have questions however, please feel free to give DSA Factors a call at 773-248-9000 to learn more about factoring. We are always happy to talk, and there is never any obligation to factor with us.