The Advance Rate and Dilution:
What is this term and why is it different on some clients? Some are 90% while others are 75%?
The amount that can be advanced to a client is generally expressed as a percentage, called the Advance Rate. Typically, this is calculated as a function of Dilution (which is the percentage of an invoice that is not returned or paid). Dilution includes discounts, returns, allowances or any reason an invoice is not paid in full. Many factors will use a multiple of Dilution (3x or 4x) to establish the Advance Rate; other factors typically just add 10% to the dilution.
Tip: You may hear or see on factoring reports the words Chargeback, Recourse, or Adjustment… these are all dilutive items.
For illustration purposes, if a client sells $10,000 in widgets to their customer and a factor advances 80%, the client would receive $8,000. Then, when the customer (debtor) pays for the products, let’s assume they only pay $7,500 claiming they had a credit on file for $2,500. Therefore, they do not pay the full amount of the invoice. The portion that is not paid is considered dilutive, or Dilution. Of the $8,000 the factor sent to the client, only $7,500 was received. The factor would still be owed $500 plus any factoring fees.
It is because of this that setting an appropriate Advance Rate is important, as well as monitoring the client’s ongoing Dilution. This also highlights why during verifications and collections factors will inquire as to open credits, other potential offsets, discounts, disputes, etc.
Chargebacks / Dilution:
Did you know that many recourse factors may ignore chargebacks after recourse to a client. For example, if an invoice hits 90 days, they may just charge it back to the client without wondering or asking Why? Since the invoices purchased should include services that are completed or goods that have been delivered, why are there chargebacks?
- Was it a discount that was pre-approved in the client’s terms if the debtor paid quickly?
- Were the goods damaged or of poor quality? Is this an ongoing issue with the client that should be watched in the future?
- Was the account debtor a bad credit risk and didn’t have the ability to pay?
- Did the debtor request a credit and rebill for a reason? Do we know the reason? Does it make sense? And, did the invoice date stay the same or did they re-date the invoice?
- What was the ultimate outcome of the chargeback? Did the invoice pay later? If so, who did the money go to? If not, why was the invoice never paid?
- Did the client ‘pre-bill’ the invoice and not finish the work?
- Are there offsets that the debtor took against the invoice that we did not know about (i.e., contra account, deposit, other open credit memo, volume rebates, year end rebates, restocking fees, co-op charges, etc)?
- Was the invoice even real?
Remember that a factor purchases (buys) an invoice from a client and gives the client money against that invoice. For example, ABC client sends in an invoice for $50,000; the factor reviews the paperwork or verifies the invoice to ensure the work is completed. They should also review the debtor’s credit to be sure they have the ability to pay the invoice. The factor then buys the invoice, advancing typically 80% against the invoice amount. In this case, on the $50,000 invoice, the client would have received $40,000. If the invoice is later not paid, then how does the factor get repaid on the $40,000?
This is the reason that reviewing invoice documentation, verifying invoices and checking debtor (customer) credit are so important to a factor. Good factors know why these chargebacks occur and manage that risk.
Wishing You Continued Success. The Factor Guru.