A basic factoring transaction has 3 parts. First is the Advance, this is the percentage of dollar amount that is funded initially. It is the percentage of the total value of the invoice. For example, if the invoice submitted is $10,000 and the advance rate is 80% then the advance will be the $8,000.
Next is the Reserve which is held back until the customer pays the invoice – directly to the factoring company. Once the payment is made then the reserve is released. Factoring companies handle the reserve differently, so be sure to understand what the offer specifies. Some companies hold a semi-permanent reserve, some batch invoices and only release the reserve when all the invoices in the batch have been paid. For example, every Friday our firm releases the reserve for all individual invoices that have been paid during the week.
Lastly is the Discount fee. This is the fee for funding the invoice. Again each factoring company handles this a little differently. When the invoice gets paid, the discount fee is taken out of the reserve and the balance is sent on to the client. All factoring companies follow this basic concept the same way.
The Advance, the Reserve, and the Discount Rate make up the invoice factoring deal.