 In yesterdays post we discussed the basic definition and calculation of loans and receivables dilution.  Today's post will focus on a more in depth analysis of different types of dilution calculations.

Historically factoring companies and asset based lenders have calculated loans and receivables dilution differently. Factoring companies have used purchased invoices as the denominator of the calculation and asset based lenders have used collections as the denominator.

Factoring Company Example -

Remember from Part 1, Returns + Allowances + Discounts = ("Dilution")

Dilution divided by sales equals dilution expressed as a percentage.

\$10,000 in dilution divided by \$100,000 in sales Equals 10%.

Asset Based Lending Example -

Dilution divided by collections = dilution expressed as a percentage.

As you would expect because collections will most always be a smaller number than sales dilution calculated this way will show a higher percentage.  I believe asset based lenders use this calculation becuase it is inherently more conversative.

Lets use the same numbers we used above for the asset based lending example.

\$10,000 in dilution divided by \$9,000 in collections equals a dilution percentage of 11%.  I have never been able to figure out why asset based lenders use this calculation other than it is fundamentally more conservative.

This same calculation can be used over any period of time.  Most of the places I have worked have used a 3 month rolling average.  The idea behind a three month rolling average is that it is more than one month so the percentage isnt distorted by one months irregular activity and not longer than three months becuase that would "smooth" the percentage to a point where current activity would not have much of an influence over the percentage.

Tomorrow's article will focus on how lenders and factors use these calculations to set advance rates. 