Essential Factoring Terms and Definitions for New Brokers
From the standpoint of truly professional home-business opportunities that qualify as well within the budget of almost all career-minded entrepreneurs, few opportunities can compare with those found in the commercial factoring and alternative commercial finance industries. In fact, at some chosen level of learning and participation, anyone and everyone with the idea of starting a business they can run from a basic home office can benefit from investing in the time it takes to become well versed regarding the power of factoring when it comes to solving cash flow problems for small business entrepreneurs. And, when it comes to investing some time acquiring the industry knowledge you’ll need to begin earning a share of factoring’s residual referral commissions, a great way to start is by learning some important industry terms and definitions so you can converse well with not only prospective clients, but factors and lenders as well. Here are some important industry terms and definitions all new brokers and agents should become familiar with.
- FACTORING: Factoring is a well-practiced method of small business financed used to accelerate payments upon accounts receivable (invoices). It is used almost exclusively by businesses selling B2B (business-to-business), invoicing for their sales, and granting attractive terms of payment to their customers. As a method of business finance, factoring does not involve lending money, but rather the actual purchase of accounts receivable at a discount.
- FACTOR: A factor is a specialized finance company or commercial bank engaged in the business of purchasing business accounts receivable at a discount though the use of factoring-styled transactions.
- ACCOUNTS RECEIVABLE: An invoice or bill tendered from one business to another party (business or individual) for goods delivered or services performed. The proper plural use of the term here is “accounts receivable”, NOT account receivables”.
- ACCOUNTS: Another term for accounts receivable or invoices.
- TERMS OF PAYMENT: Terms of payment are an accommodation offered by a business that is a seller of goods or services which typically provides for an extension of time for a buyer to pay a bill or invoice when an order is completed. In most industries, the most common terms of payment offered between businesses are 30 days. Terms of payment are often used to attract new customers who can benefit from the accommodating payment delay, often allowing them to be able to re-sell and profit from products on a retail basis before actually paying for the same products on a wholesale basis.
- CLIENTS: Business owners that sell their invoices to and employ the services of a factor are termed “Clients” of that factor.
- CUSTOMERS: Business owners in a B2B sales transaction that are scheduled to pay upon invoices representing valid sales and services already provided are called “Customers”. Factors purchase invoices from clients that are payable by the client’s customers.
- FACTORING FEE: The fee (typically quoted as a percentage) the factor charges for its services. Total fees charged by factors usually relate to the time (in days) an invoice remains outstanding after purchase from the client.
- DISCOUNT: Another term for for the factoring fee but usually referenced as a “quote” for a 30 day period.
- ADVANCE or INITAL ADVANCE: An advance of funds made by a factor to a client when purchasing accounts receivable.
- ADVANCE RATE: Not to be confused with discount rate, the advance rate is a “multiplier” and is by a factor to determined the amount of “funds employed” for an initial purchase or invoices. The most common advance rate in the factoring industry is 80 – 85%.
- RESERVE RATE: Also called the “Factor’s Reserve”, the reserve rate is the percentage of the face value of invoices to be purchased which is not included or “set aside” in the factor’s advance of funds. For example, a factor advancing with an 85% advance rate, will have a 15% reserve rate. The factor’s reserve acts as a “financial cushion” in a factoring arrangement and insulates to factor from potential losses that can occur when a customer does not pay the full face amount of an invoice. Reserves that are a bookkeeping entry at the time of advance are termed simply reserve or “uncollected reserve”. Once purchased invoices are paid, uncollected reserve is now collected reserve and is available for distribution.
- RESERVE DISTRUBUTIONS: Reserve distributions or “rebates” are periodically made by the factor to the client when there is excess reserve that has accumulated. Reserve distributions are made after all factoring fees are paid. For example, if a $10,000 invoice is purchased at an 85% advance rate, the client will receive an $8,500 advance of funds. If after 30 days, the client’s customer pays the full $10,000 face amount due, a $1,500 collected reserve is created available for payment to the client as a reserve distribution or rebate as well. Prior to this distribution, however, accumulated factoring fees for the transaction (of say $300) will be deducted.
- VERIFICATION: This is the validating process performed by a factor’s back office that “verifies” that an invoice scheduled to advanced upon is valid and that the goods evidenced upon the invoice have actually been delivered to the customer or the services evidenced upon the invoice have actually been performed.
- NOTIFICATION: Notification or notification of assignment is one of the most important tasks of the factor’s back office and involves a legal notice sent to the customers of a factor regarding the requirement to and directing them to submit all future invoice payments directly to the factor and no longer to the client. Proper notification prevents a client from being paid twice on the same invoice. Once properly / legally noticed, a customer must adhere to that notice and make certain the factor, and not the client, receives all future invoice payments (whether factored or not).
- BUSINESS DEVELOPMENT OFFICER: A business development officer or BDO is a salaried member of a factor’s staff charged with acquiring new clients for the factoring firm or factoring bank. Very similar to a loan officer at a commercial bank.
- BROKER: A broker, sometimes referred to as partner, agent, consultant, etc., is an independent source of referral to the factoring firm. All brokers are independent “commissioned” contractors and unlike BDOs, are not salaried by the factor. They are, instead, highly compensated for business referrals through exceptionally attractive broker commission arrangements. Often, factoring industry brokers are also community business professionals such as accountants, tax preparers, attorneys, lease brokers, bank loan officers, etc. In some cases, brokers are independent freelance “business finance consultants” that work with and counsel small business owners in need of and seeking non-bank alternative financing for their companies. Well-trained independent freelance brokers are a much sought after commodity in the factoring industry.
- COMMISSION: This refers to the compensation paid to independent brokers / contractors for their client referrals to a factor. In the factoring industry, commissions paid to referring brokers are unique and almost always residual, meaning the broker will earn commissions each and every month that their referral continues to use the services of the factor.
Get Started in Factoring
As we previously said, almost anyone can learn enough about factoring, and especially with all of the training and content available through IACFB, to participate in the industry at some level and begin earning residual referral commissions. Most seeking to do so, can start exceptional home-businesses for just pennies a day that can ultimately lead to a comfortable six-figure income. If you are one of today’s growing ranks of home-based mobile creative business opportunity seekers and find the lucrative but under-the-radar business of loan brokering and alternative business finance exciting, maybe you should invest the time to learn more by joining the IACFB’s LinkedIn Group and visiting the IACFB Factoring Broker Magazine at Commercial Finance Consultants.com.