The factoring transaction happens in three parts. The first is the Advance. This is a percentage of the face value of the invoice that is wired into your bank account when it is submitted for financing. The industry average is 80%. This means when a $100,000 invoice is submitted for funding, and the customer’s credit looks good, they have been notified and the invoice is verified – the factoring company will wire $80,000 into your bank account to be used to grow your business.
The percentage of the advance may vary depending on the industry and creditworthiness of the account debtors. Some industries require a lower advance percentage because unfortunately they are inherently riskier.
The second part is the Reserve. The remaining percentage of the face value of the invoice is held back waiting until the customer pays the factoring company. Some factors handle the reserve account in different ways, so this a good question to ask a potential factoring company – How do you handle the reserve account? We disperse our reserve accounts every week and do not have a permanent hold back.
The last part is the actual cost of funds. This is where the factor gets paid. When the customer pays the invoice directly to the factoring company, the cost of funds (the fee) is deducted and the remaining reserve goes back to the client.
One of the benefits of factoring is once the transaction has passed through the three parts, it is retired. The invoice is paid, the debt is settled and there are no outstanding liabilities on your balance sheet.