A reserve is a provision to cover short payments, payment of less than the full amount of the invoice by the debtor, or a payment received later than expected.
The result is an initial payment followed by a second one equal to the amount of the reserve if the invoice is paid in full and on time or a credit to the account of the seller with the factor.
In an ongoing relationship the invoice seller will get their funds one or two days after the factor receives the invoices.
Astute invoice sellers can use a combination of techniques to cover the range of 1% to 5% plus cost of factoring for invoices paid within 50 to 60 days or more.
In many industries, customers expect to pay a few percentage points higher to get flexible sales terms.
In effect the customer is willing to pay the supplier to be their bank and reduce the equity the customer needs to run their business.
To counter this it is a widespread practice to offer a prompt payment discount on the invoice.
This is commonly set out on an invoice as an offer of a 2% discount for payment in ten days. {Few firms can be relied upon to systematically take the discount, particularly for low value invoices - under $100,000 - so cash inflow estimates are highly variable and thus not a reliable basis upon which to make commitments.}
Invoice sellers can also seek a cash discount from a supplier of 2 % up to 10% (depending on the industry standard) in return for prompt payment.
Large firms also use the technique of factoring at the end of reporting periods to ‘dress’ their balance sheet by showing cash instead of accounts receivable There are a number of varieties of factoring arrangements offered to invoice sellers depending upon their specific requirements.
The basic ones are described under the heading Factors.
