The Accrued Reserve is just the portion that the factor didn’t advance to the client; it’s the amount the factoring company is holding back until the invoice pays, in the event their customer (the account debtor) short pays, disputes, discounts, or for whatever reason doesn’t pay the full amount of the invoice.

Accrued (sometimes referred to as Escrowed) Reserves are created when a factoring company purchases an invoice from their client. The invoice amount, less the initial discount fee (typically), less the amount advanced to the client is what then goes into the Accrued Reserve.

Once an invoice pays and the factoring company has received actual cash, this payment then pays back the factor for their advance, pays the factoring fees earned/accrued and creates what is called a cash reserve.

The below calculation and example assumes (i) an 80% advance (or purchase) rate, (ii) a 1.75% discount fee for the first 30 days from when the invoice was purchased by the factor, and (iii) the invoice paying in 30 days or within the initial 30-day period:

Invoice Amount Totals:  $263,500

Advance Rate 80%:  $210,800

Discount Fee 1.75%: $4,611

Wire Charge: $12

Advance less wire fee:  $210,788 (Amount that Client receives)

Ending Accrued Reserve: $48,089

Note the Accrued Reserve is the portion that is not advanced but being held back by the factoring company. When the invoice pays in full (assuming it pays in full), the Accrued Reserve would convert to a Cash Reserve and be returned to the client.  

The Accrued Reserve would decrease if the invoice paid after the 30-days, based on the additional fees charged by the factor, thereby reducing the Cash Reserve back to the client. The above example illustrates the invoices paying within 30 days only.

Wishing you success. The Factor Guru.

Generally, these sales are for completed orders (for goods delivered or services rendered). This includes a variety of industries including, but not limited to, manufacturing, staffing, transportation and logistics, distributing, importing/exporting, medical and healthcare businesses, oil and gas, consulting, IT and technology, services, construction and many others. Some factoring companies will finance progressive or milestone billings, although this tends to be the exception more than the normal course of operation.

Once the invoices have been sold to the factor, the client receives an ‘advance’ of anywhere from 50% to 95% of the invoice, with an average advance rate more likely at 80% to 85%. Advance rates depend on the industry in which the client operates, billing practices of the client, and payment patterns of the account debtors. For example, a client in the construction industry may have offsets for subcontractor payments, retainage, and other industry related offsets. In this case, a lower advance rate may be warranted. On the other hand, staffing and transportation businesses tend to have fewer reasons for non-payment of an invoice, resulting in a higher advance rate being offered.

Assuming an 80% advance rate, the factor would then retain a 20% ‘reserve,’ which would be released back to the client once the account debtor has made payment to the factor (less the factoring or discount fees that have been earned and/or accrued).  Before these payments are made to the factor, this reserve is often called an ‘accrued’ or ‘escrowed’ reserve. Once the payment has been received, however, this reserve becomes a ‘cash’ reserve, assuming full payment of the invoice (or at least the funds advanced plus fees) has been received. Factors may hold cash reserves for other potential invoices that are aging out on the factor’s books, have known disputes, or where other credit criteria may deem holding such cash reserves necessary.

Factoring can be a useful tool to companies seeking capital or needing to increase their working capital cycle. Stay tuned for more details on the inter-workings of factoring and its importance to helping companies manage their cash and their receivables while focusing on the growth of their business.  

For reference, you may want to read Wikipedia, which has a good general overview of factoring including a brief history. About.com also had some other reference information on the benefits of factoring.

Happy reading. The Factor Guru.