There are three parts to an invoice factoring transaction. The first is called the “advance.” This is the amount the factoring company pays you when they fund your invoice. It is a percentage of the total face value of the invoice to your customer. Typically the advance is around 80%, it might be higher for less risky invoices to high quality creditworthy customers, or it may be lower for certain industries that are problematic like construction related companies.
The second part is called the “reserve” which is the percentage of the invoice held back in anticipation of the customer paying their invoice. The reserve on an 80% advance would be 20%. The reserve protects the factor from losses occurring from non-payment of invoices and to insure the ability to collect the fees related to the factoring transaction.
So the last part is called the “discount fee.” This is what the factoring company charges its client to transact the financing. The discount is a pre-determined percentage of the face value of the invoice. When the customer pays the invoice, the factor deducts the fee out of the reserve account and the remainder of the reserve is sent on to the client.
Some factors combine multiple reserves based on how the invoices were submitted. For example if you were to submit five invoices, those factoring companies only release the reserve upon all five invoices being paid off. Other factors have a policy of permanent reserve meaning they hold back a percentage permanently throughout the factoring engagement.
Here at Creative Capital Associates, we do neither of these activities with your reserve. We treat each invoice as a separate transaction and once the invoice gets paid, you get the full remainder of the reserve.
This helps to illustrate how straight forward and easy invoice factoring is to understand as a commercial finance mechanism.