There are three components that make up a factoring transaction.
There is the ADVANCE. This is the dollar amount that is funded initially. It is a percentage of the total value of the invoice. For example if you have submitted a $10,000 invoice and your advance rate is 80% then your initial funding will be the $8,000.
There is the RESERVE. This is held back until the customer pays the invoice – directly to the factoring company.
Once the payment is made 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.
And lastly there is the DISCOUNT RATE. This is the fee for funding the invoice. Again each factoring company handles this a little differently. To compare them evenly figure on what the cost is for an invoice that has aged 30 days. If the invoice gets paid within 30 days the fee will be X. Then you get into many permutations of what happens after the initial 30 days.
When the invoice gets paid, the discount fee is taken out of the reserve and the balance is sent back to you.
The Advance, the Reserve, and the Discount Rate make up the factoring deal.