Dilution of receivables

In a financing backed by trade receivables (factoring, borrowing base facility, securitisation), dilution measures the share of the financed invoices that the company will not collect for a reason other than its customer’s insolvency. The European definition of factoring covers any situation that reduces the value of an outstanding invoice, except the debtor’s default. The causes are credit notes, early payment discounts, rebates, returned goods, invoicing errors and commercial disputes. The dilution rate divides the total of these adjustments by the amount of receivables over a period: €10,000 of credit notes and discounts on €100,000 of invoices gives a rate of 10%. The amount advanced on a diluted invoice no longer has a matching collection. The lender protects itself in two ways. It holds back a reserve on the financed receivables, or it lowers the advance rate applied to the portfolio, by one point for each point of dilution above a threshold in some grids. Before putting a contract in place, the factor asks for a view of one year of management of the receivables ledger, including aged balances and the rate of credit notes and unpaid invoices. Some lenders count bad debts as dilution, which raises the measured rate.

A distributor of hygiene products assigns €60m of invoices per quarter. Over the past year, it issued €3.6m of year-end credit notes and €1.2m of credit notes for disputes, or €4.8m on €240m of invoices and a dilution of 2%. The lender sets a dilution reserve of 4% of eligible receivables, deducted from the base before the advance rate is applied.

• Have the contract state whether bad debts count as dilution.
• Present twelve months of credit notes broken down by customer and by reason to measure your rate.
• Negotiate a dilution reserve recalculated each quarter on the observed rate.
• Exclude from the calculation the discounts already deducted from the invoiced amount.