The reserve amount in the context of invoice factoring and trade finance is a portion of the invoice value that the factoring company holds back as a security measure until the customer pays the invoice in full. This reserve provides the factor with a safety net to cover any potential deductions, disputes, or non-payments. Once the invoice is settled by the customer, the factoring company releases the reserve amount to the business, minus any fees or charges.

Key Aspects of the Reserve Amount:

1. Definition:
   • The reserve amount is the percentage of the invoice value that the factoring company retains as collateral until the customer pays the invoice. It acts as a buffer to protect the factor against risks associated with non-payment or disputes.
2. Calculation:
   • The reserve amount is typically a percentage of the total invoice value, often ranging from 10% to 30%, depending on the agreement between the business and the factoring company. For example, if the invoice value is £10,000 and the reserve percentage is 20%, the reserve amount would be £2,000.
3. Advance and Reserve Split:
   • Advance Payment: The factoring company provides an advance on the invoice value, usually around 70-90%. Using the previous example, with an advance rate of 80%, the business would receive £8,000 upfront.
   • Reserve Amount: The remaining 20% (£2,000) is held as the reserve.
4. Release of Reserve:
   • Once the customer pays the invoice, the factoring company deducts its fees and any other charges from the reserve amount and then releases the remaining balance to the business. If the customer pays the full invoice amount of £10,000, and factoring fees total £500, the factor releases £1,500 to the business.
5. Importance:
   • Risk Mitigation: The reserve amount helps the factoring company manage risks related to non-payment, disputes, or other potential issues with the invoices.
   • Financial Planning: For businesses, understanding the reserve amount is essential for cash flow planning. It ensures that they are aware of the funds they will receive upfront and the amount held in reserve.
6. Usage:
   • Adjustments: The reserve can be used to cover any shortfalls if the customer pays less than the invoice amount due to disputes or returns.
   • Fees and Charges: Factoring fees and any other agreed-upon charges are deducted from the reserve amount before it is released to the business.

Example of Reserve Amount in Practice:

A UK-based company factors an invoice worth £20,000 with a factoring company. The agreement specifies an advance rate of 85% and a reserve amount of 15%.

• Invoice Value: £20,000
• Advance Rate: 85%
• Reserve Percentage: 15%

Calculation:

• Advance Payment: £20,000 × 85% = £17,000 (paid upfront to the business)
• Reserve Amount: £20,000 × 15% = £3,000 (held by the factor)

Once the customer pays the £20,000 invoice, the factoring company deducts its fees, say £500, and then releases the remaining reserve balance:

• Remaining Reserve: £3,000 – £500 = £2,500 (released to the business)

Conclusion:

The reserve amount is a crucial element in factoring agreements, providing security for the factoring company and ensuring that businesses have a clear understanding of their cash flow. By retaining a portion of the invoice value, the factoring company can mitigate risks, and businesses can effectively manage their finances, knowing the exact funds they will receive upfront and upon the settlement of invoices.