Factoring 101 Basics: Learning How To Speak “Factorese”

For new consultants entering the factoring industry, mastering the relevant terminology is essential. This knowledge not only facilitates clear communication with clients and industry professionals but also enhances your ability to navigate and succeed in the field. Here’s a comprehensive guide to some of the most important terms you need to know.

  • Accounts Receivable or simply Account:  Accounts Receivable (AR) refer to the money owed to a business by its customers for goods or services delivered but not yet paid for. In factoring, these receivables are sold to a factor to improve the business’s cash flow.
  • Client: Is the business that is selling its invoices to a factor.  As a broker / referrer, you will refer clients to factors and lenders to earn your commission
  • Factor: A factor is a financial institution or a specialized company that purchases accounts receivable from businesses at a discount, providing immediate cash in exchange for the right to collect future payments from the customers.
  • Factoring Agreement: This is a contract between the business (client) and the factor outlining the terms and conditions of the factoring arrangement. It includes details on the advance rate, fees, recourse provisions, and other relevant terms.
  • Advance or Advance Rate:  The advance rate is the percentage of the invoice value that the factor pays upfront to the business. Typically ranging from 70% to 90%, the remainder is held back until the customer pays the invoice.
  • Discount Fee:  The discount fee, also known as the factoring fee, is the cost charged by the factor for providing the factoring service. It is usually expressed as a percentage of the invoice value and can vary based on the agreement and the creditworthiness of the debtors.
  • Recourse Factoring:  In recourse factoring, the business retains the credit risk associated with the accounts receivable. If the customer fails to pay the invoice, the business must buy back the unpaid invoice or replace it with another one.
  • Non-recourse Factoring: In non-recourse factoring, the factor assumes the credit risk. If the customer defaults on the invoice, the factor absorbs the loss. This type of factoring typically comes with higher fees due to the increased risk taken on by the factor.
  • Notification of Assignment: This is a formal notice sent to the business’s customers informing them that their invoices have been assigned to a factor. It instructs them to make future payments directly to the factor.
  • Debtor or Customer: In the context of factoring, a debtor is the business’s customer who owes money on the accounts receivable that have been factored. The debtor is responsible for paying the factor instead of the original business.
  • Credit Approval:  Credit approval is the process by which a factor evaluates the creditworthiness of a business’s customers (debtors) before agreeing to purchase the accounts receivable. Factors rely on this assessment to mitigate risk.
  • Reserve Account: A reserve account is an amount withheld by the factor from the initial advance. This reserve is released to the business once the factor collects the full invoice amount from the debtor, minus any fees or deductions.
  • Reserve Distribution: Is commonly referred to as a “rebate” and  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 payment of 100% of the invoice face amount.  The 15-20% not initially advanced on the invoice is reserve and will now be distributed to the client after the factor’s fee (which includes your commission) is taken out.
  • Invoice Verification: Invoice verification is the process by which a factor confirms the validity and accuracy of the invoices before purchasing them. This step helps prevent fraud and ensures that the factor only buys genuine receivables.
  • Chargeback:  A chargeback occurs when an invoice is returned to the business by the factor due to non-payment by the debtor. The business must then either replace the invoice with a new one or repay the amount advanced for the unpaid invoice.
  • BDO or Business Development Officer:  In a factoring firm the Business Development Officer or BDO is an employer charged with sourcing new clients for the factoring firm.  Additionally, Business Development Officers are often charged with developing networks of independent brokers and consultants.
  • UCC:  Is short for the Uniform Commercial Code which is a body of law adopted by the United States which regulates financial transactions.
  • UCC Search:  is an online search and part of the due diligence performed by the factor to ascertain if it can perfect a first position senior lien in accounts receivable of a new prospective client.

Understanding industry terminology is crucial for factoring consultants because it equips them with the precise language needed to navigate the complexities of the factoring process effectively. Mastery of these terms allows consultants to communicate clearly and confidently with clients, financial institutions, and other stakeholders. This not only builds trust and credibility but also ensures that consultants can accurately explain factoring agreements, negotiate terms, and address any issues that arise. Furthermore, a solid grasp of industry-specific terminology helps consultants avoid misunderstandings, streamline transactions, and provide expert guidance, ultimately leading to better outcomes for their clients and their own professional success.