Loss reserve

A funder writing a book of advances knows some will fail. Rather than recognise those losses only when they occur, it estimates them in advance and books a reserve against the portfolio, reducing reported earnings now for losses expected later.

How the estimate is built

Static pool analysis is the usual method: group everything funded in a given month, track how much of it was collected over time, and use the curves from mature pools to project the immature ones. The pools get cut by industry, by position, by time in business, by ticket size, by whether the deal was a renewal, and by originating channel — which is how funders discover that a particular ISO's submissions default at a different rate from the rest of the book.

Why it sets your price

The pricing on any funding product has to cover cost of capital, operating cost, acquisition cost including broker commission, expected losses, and a return. Expected loss is the largest and most variable of those in high-risk short-term funding, so a funder's loss experience is the main determinant of its factor rates. This is also why price differs so sharply by industry and by position: the funder is not judging your business individually so much as pricing the pool you have been sorted into.

For banks

Regulated institutions follow the current expected credit loss standard, which requires lifetime expected losses to be recognised at origination. The mechanics differ from a private funder's approach; the economic logic is the same.