Advance rate, discount and reserve: the three numbers that decide what factoring pays you

Three numbers govern every factoring transaction. Get them straight and the rest of the agreement becomes readable.

The full worked example

Illustrative only — a $50,000 invoice. The advance rate is 85%. The fee structure is 2% for the first 30 days, plus 0.5% for each 10 days or part thereof after that. Your customer pays on day 38. All figures are constructed to show the mechanics; they are not a market quote.

What that cost actually is

The fee is $1,250 on a $50,000 invoice, so 2.5% of face value.

But you did not have $50,000 for 38 days. You had $42,500. The cost against the money you actually received is $1,250 ÷ $42,500 = 2.94% over 38 days. Annualised on a simple basis, 2.94% × (365 ÷ 38) ≈ 28.3%.

That annualised figure is shown so the comparison with an interest-bearing product is possible at all. It is not an APR, it excludes every other fee in the facility, and it assumes 38-day payment repeats all year. Do not quote it back to a factor as though it were their rate. Do use the method when you are comparing factoring against a line of credit, because a line quoted at an annual rate and a factoring facility quoted per invoice are otherwise not comparable in any direction.

Why the advance rate is not the whole story

A higher advance rate means more cash on day one and a smaller reserve. It does not change the total cost, which is set by the discount. A factor quoting a higher advance rate than another is offering you more day-one liquidity, not a cheaper deal.

Two things move the advance rate:

Where the reserve gets complicated

The reserve is not always released invoice by invoice. Read how yours works, because the variants differ materially:

Ask which one applies, and ask whether the factor can raise the required reserve at its discretion. Many agreements allow it, and a reserve increase is a funding cut delivered under a different name.

The netting question

Ask how the factor handles a month in which chargebacks exceed new fundings. The answer is usually that the shortfall is deducted from the next advance or demanded on the spot. Knowing this in advance is the difference between managing it and being surprised by it in a payroll week.

What a short-paid invoice does to all three numbers

The clean example above assumes your customer pays the face amount. Often they do not. A deduction for damage, a short shipment, a rebate, an early-payment discount they took without asking — all of it lands in the reserve, because the reserve is the only part of the transaction that has not already been paid out.

That is the correct outcome — the deduction was your commercial issue, not the factor's. What matters is that you can see it coming. If your industry runs deductions of any size, model the reserve at a level that absorbs them, and check whether the agreement charges the fee on face value or on the amount collected. Face value is more common and it is more expensive when short payments are routine.

Recourse is the fourth number

The three numbers price the transaction. Recourse decides who eats an invoice that is never paid at all. In a recourse facility, an invoice unpaid after a defined period — often 60 or 90 days past due, and the number is in your agreement — is charged back: the factor recovers the advance from your reserve, or from the next advance, and the invoice comes back to you along with the collection problem.

Ask three things. What is the chargeback period in days. Is it measured from invoice date or due date. And does the factor keep the discount it already charged on an invoice it hands back. The answer to the third is usually yes.

Three lines to add to your own model

1. Cash on day one, per typical invoice.
2. Cash on reserve release, per typical invoice, net of every fee.
3. The days between the two, using your own ledger's actual average days to pay — not the factor's assumption and not your terms.

Point three is where forecasts go wrong. If your terms say net 30 and your customers pay in 47 days, model 47. Every fee structure in factoring charges for time, and time is the input you already have data on.