Whether you have used Invoice Factoring in the past to fund your working capital needs or are researching to see if the factoring of your company’s invoices is right for you, it is important to understand Invoice Factoring Terminology so you can be a well-educated business owner. Businesscash.com has created this Glossary for your use.
First, what is Invoice factoring? It is the selling or assigning of your unpaid invoices to creditworthy clients to a Factoring Company. Once your invoices are verified and assigned to the Factoring company, a Factor will advance you up to 92% against your invoices. Here are some of the terms you will hear when discussing Invoice factoring.
Advance Rate: This is the percentage that a Factoring Company will give you as part of your daily or weekly funding. For example, the factor approves a batch of invoices from you totaling $30,000. Your agreement with the Factor stipulates an 85% advance rate. You will be wired approximate $25,500.
Debtor: This is your client who owes the debt of payment to the factor and subsequently you. Since you are the Factoring Companies customer it cuts down on confusion versus talking about the client’s client.
Dilution: Sometimes you have to offer your clients a discount or they take a chargeback or deduction. It is important that the Factor knows about this as they compute your funding based on your Advance Rate times the face value of your invoices less any dilution.
Factoring Fee: This is the cost to you of Invoice Factoring. Fees can be anywhere from .6% to 4% per 30 days depending on several risk variables including industry, creditworthiness of your client and dilution chance.
Invoice: An invoice or bill is a commercial document issued by a seller to their customer (the Debtor), which lists the product’s or service’s description, quantity and agreed upon price the seller has provided the buyer. An invoice also indicates the buyer must pay the seller, according to the payment terms. The buyer has a maximum number of days in which to pay for these goods and is sometimes offered a discount if paid before the due date. An Invoice is a legal document and many times companies do not protect themselves with the correct verbiage on the invoice. A good Factoring Company can help you make sure you are fully protected by reviewing the language on your invoice.
Proof of Delivery: A Factor will want to confirm that your client (the Debtor) has received the goods or services described in your invoice to the Debtor’s satisfaction.
Recourse: The factor assumes no credit responsibility and invoices can be charged back to you at any time. This is risky for you unless you are selling to the very strong, creditworthy entities like a Wal-Mart or the US Government. Remember what happened to Circuit City and Linens and Things? There is one thing worse than no sales and that is selling the product and not getting paid.
Reserve Account: Invoice Factoring is a two-part process. First is the initial Advance and secondly is the release of the Reserve less the Factor’s Fee once the invoice is paid. Occasionally a Factoring Company will hold a percentage of your Reserves if there is a history of chargebacks or to offset against any bad invoices.
Sales Terms: This is the Payment Terms you give your customer which needs to be stated clearly on the invoice. Typical terms are Net 30 days or Due on the 10th day of the following month. Terms can also be combined. For instance, many companies sell on 2% 10 days, Net 30. Which means the client receives a 2% discount if they pay within 10 days but the invoice is due by the 30th day without a discount.
Without Recourse: The Factoring Company bears full responsibility for credit approval based solely on the Debtor’s financial ability to pay invoices according to the stated terms. There is also Limited Recourse were you covered in the event your client files for bankruptcy protection. Many times this is the most cost-effective way to Factor your Invoices as the Factoring Company can use Credit Insurance to mitigate that risk.