The factoring reserve is the amount a factoring company holds in reserve until a debtor pays the invoice. Once the debtor pays the invoice, the factoring company pays the reserve—or rebate—to the business that sold its invoice to the factoring company. The factoring company keeps a percentage, called the factoring rate, which is its fee for facilitating the transaction.
Factoring transactions include two separate disbursements from the factoring company; the first, called the advance, is paid upfront upon receipt of the invoice while the other, called the rebate, is held in reserve. Depending on prior negotiations between the factoring company and the business owner, the advance can be between 80% to 90% of the total invoice. In comparison, the remaining 10% to 20% is held in reserve until such time the invoice is paid.
How a Factoring Reserve Account Works
When a factoring company provides an advance, it keeps part of the invoice value in reserve. This helps protect the factor from risk and gives it some cushion for fees. The total reserve for an invoice depends on several factors, including the amount being financed, the reliability of the debtor, and the industry of the business.
Once a factoring company collects the invoice, it deducts the fees from the reserve amount and forwards any difference to the business. While individual fees vary, most factoring companies charge an increasing fee dependent on how long the invoice is outstanding. Most business owners will have a continuous reserve as they factor invoices every month.
Factoring Reserves for Two Types of Factoring
The two types of factoring reserve are recourse and nonrecourse factoring, with the former being the most common. In recourse factoring, the business owner assumes the risk. The loss brought about by the nonpayment of the invoice falls on the business owner. The business owner will have to buy back an invoice that the factoring company cannot collect payment on.
In nonrecourse factoring, it’s the factoring company that takes on most of the risk. However, the factoring company typically passes some risk on to the business owner in the form of stipulations in his contract. The factoring company also protects itself with the reserve account so it can cover the invoice losses.
Factoring Reserve Account Example
To understand the factoring reserve better, let’s say a business wanted to factor an invoice valued at $10,000 with a factoring company that offered an advance rate of 75%. The reserve would be 25% of the value of the invoice, which is $2,500.
Factoring Advance %
Factoring Reserve %
Factoring Companies With Low Reserve Requirements
While the size of the factoring reserve may not be the most important consideration for a small business, it can play a role sometimes. The size of the advance affects the overall cost of funding and can make a sizeable difference in cash flow management. Small business owners in low-risk industries can expect low overall reserve rates from BlueVine and altLINE.
The factoring reserve is an essential part of the debt factoring process—the process in which a business sells its receivables in the form of invoices to a third party (the factor). The factoring reserve ensures the factor against debtor nonpayment and holds the borrower accountable.