Legal Definitions - factorage

In finance, the terms factor, factorage, and factoring are closely related. To understand them, it's helpful to first define a factor:

A factor is a financial institution or company that purchases a business'saccounts receivable (money owed to the business by its customers) at a discount. By doing so, the factor provides immediate cash to the business and takes on the responsibility and risk of collecting those debts from the customers.

Now, let's define factorage and factoring:

Factorage

Factorage has two primary meanings:

1. The compensation or fee paid to a factor for their services.

   • Example 1 (Manufacturing): A small custom furniture manufacturer sells its invoices (accounts receivable) to a factor to get immediate cash flow for purchasing materials. The factor charges a 3% fee on the total value of the invoices for this service. This 3% fee is the factorage.

   • Example 2 (Tech Startup): A new software development company has several large corporate clients who pay on 60-day terms. To cover operational costs and payroll while waiting for these payments, the startup uses a factor. The factor charges a flat 2.5% of the invoice value for handling the collection and providing upfront cash. This 2.5% is the factorage.

   • Example 3 (Wholesale Distributor): A food distributor sells goods to supermarkets and restaurants. To manage cash flow and reduce the administrative burden of chasing payments, they engage a factor. The factor's service includes purchasing the distributor's outstanding invoices and managing collections, for which they charge a variable rate based on the age and risk of the receivables. This charge is the factorage.

2. The business or profession of acting as a factor.

   • Example: A specialized financial institution focuses solely on providing working capital solutions to small and medium-sized businesses by purchasing their accounts receivable. This institution is engaged in the business of factorage.

Factoring

Factoring is the financial transaction itself, where a business sells its accounts receivable (invoices) to a third party (the factor) at a discount. The business receives immediate cash, and the factor assumes the risk and responsibility of collecting the payments from the original customers.

• Example 1 (Construction Company): A construction company completes a project and issues a $100,000 invoice to its client, payable in 90 days. To fund its next project sooner, the construction company sells this invoice to a factor for $97,000. The factor now owns the invoice and will collect the full $100,000 from the client when it's due, bearing the risk if the client delays or defaults. This entire process is an example of factoring.

• Example 2 (Apparel Brand): An emerging apparel brand needs capital to produce its next clothing line but has many outstanding invoices from retailers. Instead of waiting months for payments, the brand sells these invoices to a financial firm at a reduced price. The financial firm then manages the collection of these debts directly from the retailers. This strategy helps the apparel brand maintain liquidity and is known as factoring.

• Example 3 (Medical Device Supplier): A supplier of specialized medical devices often deals with hospitals that have long payment cycles. To ensure a steady cash flow for research and development and inventory, the supplier regularly engages in factoring, selling its outstanding invoices to a financial company. This allows the supplier to receive cash quickly, even though the financial company assumes the risk of collecting from the hospitals.