There is a lot of jargon in commercial finance, particularly around factoring. This jargon can make it difficult for companies like yours to find the financing options best suited for your needs and make comparing options between finance companies almost impossible. It is helpful to understand the basics of factoring to break down financial jargon and know the various terms used to describe the practice and how it differs from similar financing options.
What Is Factoring?
The basics of factoring include using your invoices to secure funding from a company called a factor or factoring firm. These firms will purchase your invoices, also called accounts receivable, from you for face value minus a small fee. The factor will usually pay your company in two transactions, except in the transportation business where one payment is more standard. The first deposit made to your company is called an advance and will be immediately available for you to pay your bills. The second payment is made after your client repays the invoice and will usually be debited the factoring fees.
What Terms Are Used To Describe Factoring?
Standard terms in commercial finance to describe factoring include accounts receivable financing, invoice factoring and traditional factoring. It is essential to distinguish between traditional factoring and other forms of the practice; however, in traditional factoring, the invoice is entirely sold to the financing firm, which takes on the risk of your client defaulting instead of leaving that risk with your business.
How Does Factoring Differ From Asset-Based Lending?
While all forms of factoring are asset-based lending, not all types of asset-based lending are factoring. For instance, your invoices and your inventory are assets you can use as collateral for financing. You can factor your invoices or accounts receivables, but you cannot use the same process for inventory financing. Financing purchase orders or working capitals are also asset-based lending practices but not under the umbrella of accounts receivable financing. Many financing firms will offer various types of asset-based lending for companies in your industry, but they may use different terms for dealing with invoice factoring.
In commercial finance, comparing your options between firms can sometimes mean knowing which services are the same with different names and which ones are different with similar names. For instance, invoice factoring and accounts receivables financing are the same, while traditional factoring transfers the liability for defaulted accounts from your company to the factor.