Factoring companies typically don’t advance the full invoice amount because they hold back a reserve for contingency purposes. If you factor a $1,000 invoice and the factoring company advances 80%, then you only get $800. If your customer doesn’t pay the invoice for whatever reason, then the factoring company at least has $200 to help cover the loss.
If you know anything about accounting, then you know that it’s best practice for any business to always have a cushion (or reserve) for possible bad debts. It’s commonly referred to as “allowance for bad debts”. You hope the reserve isn’t needed, but you hold it back just in case.
Some factoring transactions may also be susceptible to charge backs, price reductions or discounts. Apparel is an industry in which retailers often reduce the invoice amount for advertising or promotional allowances. Construction invoices are often reduced by a contractor for any number of reasons. Sometimes a customer may pay short for quality or service issues.
All of these are examples of why factoring companies advance only a portion of the invoice and hold back a reserve.
