Why Does an Invoice Factoring Company Hold Back or Reserve a Percentage of Your Invoice?
Table of contents
- Why Does an Invoice Factoring Company Hold Back or Reserve a Percentage of Your Invoice?
- What is an Invoice Factoring Reserve?
- Example Invoice Factoring Transaction
- What does a factoring reserve mean?
- Factoring Reserve Accounts Reduce Risk
- How does factoring accounts receivable work?
- Why do companies sell or factor their receivables?
- Types of Factoring Reserve Accounts
- Reasons for a Factoring Company Reserve Policy
- Difference between Reserve Rate and Discount Rate
- Why might a company factor (or sell) their accounts receivable with recourse vs without recourse?
- Ready for the owner-employees of Bankers Factoring to help you grow your business with invoice funding, including bad debt protection? Use our fast online factoring application or call the toll-free number 866-598-4295.
What is an Invoice Factoring Reserve?
Factoring companies hold back a portion of your sold invoices called the reserve account for contingency purposes. In invoice factoring, a reserve helps reduce risk in chargebacks, credit memos, or vendor returns. The factoring transaction has two total disbursements: initial cash advance and rebate.
When your customer pays your invoices, the reserve fund is rebated, less factoring fees.
Example Invoice Factoring Transaction
- Your company sells open invoices to accelerate payment times and receives up to 93% initial cash advance with Bankers Factoring.
- Your reserve account will save the remaining unpaid balance until your customer pays. Once your customer pays, you can claim the released amount to your factor rate.
- The rebate or discount settles the factoring transaction; if your customer submits chargebacks above your discount rates, the transaction does not close.
- Factoring reserves minimize risk from bad debt and protects our clients.
What does a factoring reserve mean?
Your factoring company advances 80 to 93% of the invoice value. The remaining receivables held back are called a reserve, and the reserve or the remaining accounts receivable (A/R) balance is paid once the invoice is paid. Reserve accounts are a risk management tool to protect factoring companies and clients from potential bad debt.
Keep reading more in our previous article Bad Debt Protection with A/R Factoring.
Factoring Reserve Accounts Reduce Risk
Holding back a portion of the unpaid A/R protects the factoring company and your business if there are chargebacks on the invoices. Some firms and industries are riskier than others when returns, defective products, and credits are more common. Reserves protect factoring companies from over-advancing funds.
How does factoring accounts receivable work?
For example, you have a factoring agreement with Bankers Factoring, a 90% cash advance, and a 1.5% discount fee. If you factor $200,000 worth of receivables, you receive $180,000 in advances, with $20,000 in the reserve account.
Once your customer pays in full, you receive a final payout of $20,000 minus the factoring fees. The factoring company collected $3,000 in fees (1.5%) at the end of the transaction if the invoice(s) paid by your customer in 30 days.
For more details, read our previous article, How Invoice Factoring Works.
Why do companies sell or factor their receivables?
Businesses in need of working capital rely on fast funding sources. Financing your A/R speeds up the customer payment period and improves cash flow. Overall, invoice factoring is an easy process compared to traditional lending.
Reasons to Sell Your Invoices:
- Fast funding process of 3 to 5 days after applying, same-day funding thereafter
- Up to 93% cash advances without taking on debt or giving up equity
- Not-yet-bankable or unbankable businesses qualify
- No repayment required, such as monthly interest payments
- Sell your unpaid receivables and receive immediate cash flow for operations and payroll
Keep reading Why Sell Your Receivables.
Types of Factoring Reserve Accounts
Most companies hold the reserve until the invoice is paid in full, then release the rebate. Other accounts may save small amounts throughout the agreement to build your reserve fund. Most arrangements have a set frequency for the distribution of discounts.
Reasons for a Factoring Company Reserve Policy
Some industries have a higher historical percentage of chargebacks. Think fresh flowers and seafood. Other industries charge their vendors for advertising, endcap, and slotting fees. Think grocery stores and retailers. Construction companies will have a 10% retainage taken right off the top.
Think about the dilution rate in your industry and your individual company. Bankers Factoring will look at these numbers when designing your personalized factoring advance rate and factoring reserve policy.
See more in our A/R Financing Glossary.
Difference between Reserve Rate and Discount Rate
The main difference between reserves and rebate rates is that discount/rebate rates relate to the cost of funding. Factoring rates are also called the factoring discount fees. This is your company’s financing cost. Reserve rates are the amount withheld in a separate account to hedge potential losses.
When your reserve accounts accumulate over time, you may decide to keep the funds saved for cash reserves or use them later for an investment. Partnering with a successful factoring company can improve your financial health and cash flow.
Keep reading more about our previous article, Understanding Factoring Rates and Fees.
Why might a company factor (or sell) their accounts receivable with recourse vs without recourse?
Recourse factoring means the customer selling its invoice is responsible for bad debt or uncollected receivables. Non-recourse factoring means the factoring company takes on credit risk for customer slow pay, insolvency, and bankruptcy. Non-recourse or without recourse offers bad debt protection to clients protecting their cash and offering peace of mind.
Keep reading Recourse vs Non-Recourse Factoring Differences.