Your go-to resource for understanding factoring terms.
Accounts Receivable (“A/R”) is money owed to a business by its customers. The term “accounts receivable” is synonymous with “invoices” and often abbreviated as simply “A/R”. Accounts receivable are created when a business bills its customers or clients for payment at a later date. Typically payment terms range from 30-90 days. One business’s A/R is another’s A/P (Accounts payable).
Invoices are essentially bills issued to a customer or client, after goods and services have been delivered or completed, for payment at a later date. Upon the issued of an invoice to a customer, the business books the revenue as Accounts Receivable (see above).
A/R Factoring is a process by which a business sells Invoices at a discount to 3rd Party Factor in exchange for the outstanding, but not overdue, invoices. In exchange for the capital, the 3rd party factor collects the invoices from the business’s customers. A 3rd Party Factor is a funding party, usually a financing institution that purchases outstanding, but not overdue, invoices from business clients. 3rd Party Factors are also known as Factoring Companies, Financing Institutions or simply: Funders or Factors. Same thing. The invoices sold by the business to the factor.
An A/R Factoring Facility is the mechanism by which a business can continuously factor its invoices to a funding party.
Discount (or Factor Fee) is the discount on A/R is the portion of the total A/R that must be paid to the factor for an advance of the remainder of the invoices. The “Factor Fee” is the same thing as the “Discount”. For example, if an invoice is $100,000, and the discount is 2.5%, then 97% will be advanced to the client, usually in two installments.
The Advance Rate is the percentage of the total invoice value that will be advanced to the client within 1 business day, as part of the purchase price. Usually 80%, but depending on the history up to 95%.
Advance Amount – $80,000 in the above example.
Escrow Reserve is the Face Value minus Advance Amount. $20,000 in the above example. Escrow Reserve only exists on outstanding and overdue invoices. Once invoices are collected, the Escrow converts into cash.
Cash Reserve is the amount of Escrow Reserve that has been converted into cash after the Invoice was paid by the Debtor. Any discrepancies between the Invoice Value and the actual receipt from the Debtor are credited to, or debited from, the business’s Cash Reserve on hand with the Factor. Factor Fees are also charged against the Cash Reserve of clients’ as invoices get paid by Debtors.
A Rebate is the amount of Cash Reserve that is distributed to the client, usually 30 days after the the invoice was paid by the Debtor. Rebates are always sent back to businesses net of all factoring fees, other fees, discrepancies, and offsets.
The Purchase Price is the advance amount ($80,000) plus, generally speaking, the Rebate. In the above example, the invoice was $100,000 and the advance rate was 80%. That means the client got $80,000 on day 1 after the Debtor received the client’s invoice. Later, when the Debtor paid, the Factor has an excess of $20,000 (-$80,000 sent to client, plus $100,000 collected from Debtor = excess of $20,000). The $20,000 is no longer Escrow Reserve, but a Cash Reserve. The Factor then charges the discount rate (2.50%, or $2,500) to the Cash Reserve, and distributes $17,500 back to the client ($20,000 minus $2,500 = $17,500 Rebate).
A Payor (or Debtor) is the customer or clients that will ultimately pay the invoice. The term payor is often used because they are the party paying the invoice, and the term debtor is also applicable because they owe the money, and are therefore indebted, or: a debtor. For A/R factoring purposes, the two terms are used synonymously. Please note payor is not a real word, it is industry lingo.
Concentration is the amount of exposure (of the risk of not being paid) you have in any single client. This can be determined on an absolute (dollar) basis, or as a percentage of the total A/R.
Concentration Limit is the amount of your total A/R owed to you by each Payor, usually represented as a percentage of the total A/R. For example. Many Factors will incorporate a concentration limit into your deal, usually around 20%. This means that if any single Debtor owes you 20% or more of the total A/R owed to your business, they will not buy or do not have to buy that invoice, or any invoices. If you are looking for an aggressive factor, look for one that does not care about concentration limits or has limits above 50%.
Accounts Payable (“A/P”) is the money your business owes to another party for goods or services received. If you buy from, and sell goods to, the same party, you may experience dilution (see definition below). One business’s A/P is another business’s A/R.
Dilution % is the amount of the receivable that has become unavailable for funding, for any number of reasons. For example, if you have a customer that is also a vendor of yours for another product, you may experience dilution. Dilution occurs when your customer-vendor nets the amount of money you owe them, with the amount of money they owe you.
Recourse is the legal right for someone to demand payment. If a business enter into a Factoring Facility and one of the invoices doesn’t get paid, then the Factor may have recourse against the business and demand payment. For this reason, recourse deals are effectively loans that are structured like a factoring deal (i.e. 80% up front, then a rebate later).
Non-Recourse means there is little to no liability in selling your Invoice because the Factor is completely assuming the risk that the Debtor doesn’t pay. The Factor is only protected by the collateralized asset being purchased. If the value of the collateral shrinks or disappears, in theory, that is a risk the Factor is willing to take.
Limited Recourse – usually non-recourse with exceptions, i.e. fraud.
UCC means the UNITED COMMERCIAL CODE. Specific to factoring is ARTICLE 9 – SECURED TRANSACTIONS (2010). These are legally binding rules to play by in the factoring industry. These rules and regulations set the parameters for interactions between Factors, Businesses and Debtors. The rules vary by State but most states have harmonized their UCC versions of the code into their own, and are almost identical with minimal exceptions.
Invoice Financing is a method of obtaining a short-term loan against your outstanding invoices. Much like factoring, only a percentage of the total A/R value is made available to the business when they borrow (50-80%, usually). This is called the “loan-to-value”, or LTV percentage. Invoice financing products are almost always a loan product, are recourse against the business and oftentimes require a personal guarantee from the owner. A/R financing is cheaper than factoring, generally, and requires a good credit score of the owner.
A Security Interest (“Lien” or “Collateral”) protects the potential legal claim a funder has to your assets in exchange for the money given to you. A security interest is filed in local county recorder offices, or with the Secretary of State for where a business is located. Security interest and “lien” are used synonymously. The assets the funder takes security in are now considered “collateral”.
A UCC Financing Statement is the document filed with county recorder or State SOS offices, describing in detail the assets collateralized by the security interest.