Glossary of Factoring Terms

Factoring is a good way for small and medium-sized companies to get a more steady and immediate cash flow. The reasons for entering into a factoring agreement are as numerous as the businesses that take advantage of factoring.

While it's a complex issue, it is something that even the small business owner can learn about and successfully handle. Start by learning some of the more common terms associated with factoring.

Factoring – A process whereby small to medium sized businesses can turn assets into profit for an immediate or steady cash flow. The company that provides factoring typically purchases some asset of the business (such as invoices or accounts receivable) for the face value minus a fee.

Factoring Agent – Most factoring companies will assign an agent to your account to help you get the account established and to maintain the functionality of the account. This person typically learns at least some facts about your business and tracks the amount factored. As a small business owner, you should use this person as a resource to be sure your account is correct at all times.

Invoice Factoring – The process of selling invoices to a factoring company. This means that cash flow is more stable and that there's no need for the business issuing the invoices to follow up on collecting from customers who haven't paid on time. It works like this – you send in your invoices and the factoring company "purchases" them for the face value minus a reserve amount (usually) and any factoring fees.

Asset Based Factoring – The process by which companies can use the assets they do have for increasing cash flow. Assets may be those not typically recognized by traditional lenders, including invoices, purchase orders and accounts receivable.

Factoring Fee – The amount charged by the factoring company to perform the service. You can think of this as the "interest rate" for the cash advance given to you by the factoring company. Some factoring companies charge a flat rate for transactions – usually a percentage of the amount being factored. Some companies charge a variable rate that depends on the amount of time it takes for the customer to pay the invoice (perhaps one percent for every ten days). There are advantages to each, depending on whether your customers typically pay on time.

Minimum Monthly Fee – Most factoring contracts will include a minimum monthly fee. That is typically reflected as the amount the factoring company expects to collect in fees from your business each month. In many contracts, the minimum monthly fee can be levied even if you don't factor any amount of money that month. Most factoring companies say they won't charge that fee except when companies choose to factor with another factoring company before the end of the current contract.

Collection Process – Remember that your customers are no longer liable to you for the amount of the invoices once you've assigned those to the factoring company. The collection process is entirely at the discretion of the factoring company. If the process is overly aggressive, you may lose customers who don't want to be hounded because their payment was a few days late.