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Factoring Terminology
- ACH - Abbreviation for “Automated Clearinghouse.” It is a means of electronically transferring funds from one bank account to another.
- 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 Payable – Monies owed to other companies for products and services.
- Accounts Receivable (A/R) - Monies due for products or services that have been already delivered and are due at a specific time in the future. Typically these refer to Business-to-Business transactions. A/R are 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 financing that is collateralized by a security interest in that company's accounts receivables. Funding amounts are determined as a percentage of the accounts receivables amount pledged.
- Advance – A percentage of an invoice face value paid to a client by a factor, at the time the invoice is sold to the factor by the client.
- Advance Rate – The rate at which money is advanced to the client by the factor following invoice presentation, and prior to the 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% and 90%.
- Aging Report – A summary of a client’s accounts receivables, listed by customer and/or length of time the receivables have been outstanding.
- Assets – Anything of commercial or exchange value a business, institution or individual owns. Assets include cash, property, and accounts receivable.
- Asset Based Lending - A form of business loan where the borrower pledges to a lender collateral, such as accounts receivable, equipment, and inventory, and represents additional repayment security against monies advanced.
- Assignment – Refers to the instance when accounts receivables are factored. The client’s right to the accounts is sold or assigned to a factor.
- Bad Debt – Unpaid receivables which have been written off as uncollectible.
- Cash Flow – The difference between cash received and cash paid out.
- Charge Back - An amount of money owed to the factor or "charged back" to the client when the factor is unable to collect the Accounts Receivable that were 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.
- Client – A company who factors it s accounts receivables.
- Concentration – The portion of a factor’s total factoring funds invested in a single customer.
- Credit - The extending of time in relation to when payment is required in return for products 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 which money is owed.
- Credit Report – a report obtained from a commercial credit agency which lists the payment history, debts, public records, and credit risk of a company or individual.
- Customer - Also referred to as the account debtor. This is the party to whom the original products or services were provided and from whom the factor shall then collect monies under the terms and conditions of the factored invoice(s).
- Debtor - The company who has received products or services from a client and will pay the resulting invoice(s).
- Dilution - The amount of risk associated with the collection of the accounts receivable including but not limited to: returns, charge-backs, trade allowances, concentrations, slow pays, and bad debt.
- Discount Rate – The amount paid by the client to the factor for the factor’s services. It is calculated by subtracting the total amount advanced and rebated by the factor from the face value of the invoice(s). The term is also referred to as the factoring fee.
- Due Diligence - When a factor conducts research to assess the creditworthiness, validity of invoices submitted, and outstanding liens, etc., of a prospective factoring client’s customers.
- Factor - The agent or organization that purchases a business’ accounts receivables and assumes collection of associated invoices from the client’s customers.
- Factoring - The selling of a businesses accounts receivable to a third party at a discount, for the purpose of obtaining immediate funding.
- Fees – Amounts charged by a Factor for: 1) the discount; 2) application and due diligence processing and/or; 3) funds transfer costs such as ACH, bank wires or overnight delivery.
- Factors Acknowledgment Form - A form used by factors to send to their clients’ customers, which verifies that a 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 receivables to a factoring agent or organization.
- Factors Fee - Refers to the discount rate the factor charges for providing advance funding of the client's accounts receivable amounts.
- Factors Services - Services provided by the factoring agent to the client on behalf of the factoring process, such as credit analysis, credit checks, collections, and accounts receivable 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 (also known as 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 reimbursing to the factor the funds advanced, in addition to fees and interest.
- Invoice – A document from a company to a customer that states the amount owed by a customer for products or services rendered by the company.
- Liabilities - Claims on the assets of a company or individual, excluding the owner’s equity. Liabilities include accounts payable, other debts, taxes owed etc.
- Limit – The maximum amount that will be advanced by a factor to a client for all customers or for a specific customer.
- Lien – A legal claim against property or other assets, submitted to state and/or county authorities. Factors commonly file a lien (UCC-1) against a client’s receivables to secure against possible loss.
- Loan – a sum of money (principal) provided to an individual or company that is to be repaid with interest. Factoring is not a loan.
- 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 rendered.
- Notice of Assignment – A document given to a customer stating the client’s invoices that have been factored, and that payment should be made to the designated factor.
- Notification – The term used when a customer is made aware that a client is factoring.
- 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.
- Rebate – The balance of the amount paid for an invoice minus the advance and fees, which is paid by a factor to a client after receiving payment from a customer. The rebate formula is: Rebate = Invoice Amount – (advance + fee).
- Recourse Factoring (also known as Full-Recourse Factoring)- In this type of factoring arrangement, the factor is protected against customer non-payment. If the customer does not ultimately pay the invoice, the client is responsible for reimbursing to the factor the funds advanced, in addition to fees and interest.
- 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, less fees, 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.
- UCC-1 - A Financing Statement (Form UCC-1) that is filed to perfect a security interest in named collateral, and establishes priority in case of debtor default or bankruptcy. UCC (Universal Commercial Code) refers to the collection of laws dealing with commercial business.
It is standard industry practice for a factoring company to file a blanket Uniform Commercial Code (UCC-1) to secure the factor’s first position security interest on the invoices funded.
The UCC is a way for factoring companies, banks, and commercial lenders to avoid confusion and misunderstandings as to who is lending on what assets. Because receivables change on daily basis as new invoices are collected and old invoices are paid, factors must file what is called a “blanket” UCC filing collateralizing all of your receivables even though you may only be factoring a portion of your sales.
It’s simply impossible for factors to file a new UCC-1 for each invoice funded. The UCC is simply an indication to other lenders, who chose to run a search, indicating a Security Agreement exists between your company and a particular factoring company.
The details of your particular factoring arrangement, such as rates and which accounts are factored are outlined in the Security Agreement itself which is not public. UCC is akin to a first mortgage on your business.
- UCC-3 - (Uniform Commercial Code-3) A document filed with the Secretary of State and/or County Recording Clerk to declare a change in a UCC-1 previously filed, such as a termination or assignment of security interest.
- Underwriting (Also Due Diligence) – Information gathered by a factor to determine whether or not to accept a client and/or customer.
- Verification – The process by which a factor confirms the validity of assigned invoices from a Client. A factor will usually determine the product has been rendered to the satisfaction of the customer, the customer intends to pay, and payment will be made to the factor.
- Volume, Monthly - The total monthly amount of invoices factored by a client.
- Working Capital - The amount of cash that a business has available to conduct its day-to-day activities. It includes monies that the owner or investors have invested in the company including retained earnings and supplier credit. A business with limited working capital benefits from factoring by eliminating the time that invoices are outstanding.
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