How an invoice factoring facility actually works, from schedule to reserve release

Factoring is a sale, not a loan. You sell a receivable to a factor at a discount and receive most of the money now. Everything that confuses people about it lives in the mechanics rather than the concept, so here is the sequence.

Before any invoice moves

The cycle, one batch at a time

The arithmetic

Illustrative only — you submit four invoices totalling $96,000. The factor approves three of them, $71,000, and holds one $25,000 invoice back because that customer is already at its credit limit.

At an advance rate of 85%, you receive $60,350 on the approved amount, and $10,650 is held in reserve.

One of those invoices is $30,000, and the customer pays it on day 41. Under a fee structure of 2% for the first 30 days plus 0.75% for each 15-day period after, day 41 falls one period past, so the fee is 2.75% — $825.

Reserve held on that invoice was 15%, or $4,500. The release is $4,500 − $825 = $3,675.

Your total on that invoice is $25,500 advanced plus $3,675 released = $29,175, which is the $30,000 face less the $825 fee. The arithmetic always closes that way, and it is worth checking that it does on your own statements.

Where the other money goes

Fees other than the discount are deducted from the reserve too, and they are the ones that do not appear in the headline quote:

• Wire or ACH fees per funding.
• A monthly minimum fee if your volume falls short of the commitment.
• Facility, set-up or due diligence fees.
• Credit check fees per new customer.
• Lockbox or platform fees.
• Chargeback and rebilling fees on returned invoices.
• Field exam or audit fees on larger facilities.

Ask for a schedule of every fee in dollars before you sign. Then reconcile your first month's statement line by line against it. If a factor's statement is not readable enough for you to do that, treat it as a finding.

Why the advance rate is what it is

The gap between 100% and your advance rate is not the factor's profit. It is a cushion sized against dilution — the share of your invoiced face value that never turns into cash because of credit memos, short payments, returns, rebates and volume allowances.

Two things follow. Your dilution history is a number the factor computes from your own ledger during due diligence, so it is worth computing first: total credit memos divided by total invoiced, over the last twelve months. And a business with low dilution has a real argument for a higher advance rate, which is worth more than a small reduction in the discount — an extra five points of advance on $100,000 of monthly invoicing is $5,000 of working capital you get a month earlier, every month.

What happens when a customer does not pay

On a recourse facility, after a set period — the recourse period, often measured in days past the invoice due date — the factor charges the invoice back to you. It recovers its advance and accrued fees from your reserve, and if the reserve is short, from your next funding. The invoice comes back to you and you chase it yourself.

On a non-recourse facility, the factor absorbs the loss, but only in the narrow set of circumstances the agreement defines, which is almost always the approved customer's insolvency and nothing else. Disputes, short payments, returns and offsets remain your problem in both structures.

The two questions that reveal a facility