Dilution is the gap between the face value of invoices and the cash eventually collected, caused by things other than customer insolvency. Typical causes are returns, damaged goods, pricing errors, promotional allowances, early-payment discounts and disputes.
How it works in factoring
Factors measure dilution because it directly reduces what they collect on purchased invoices. A common way to express it is:
Dilution rate = non-cash credits over a period / gross invoices over the same period
Illustrative example: A food producer invoiced $1,000,000 over six months and issued $40,000 in credits for returns, short shipments and promotional deductions. Its dilution rate for that period is 4%.
Higher dilution usually leads to:
- A lower advance rate, leaving a larger reserve to absorb deductions
- More detailed invoice verification
- Closer tracking of customer deductions and chargebacks
Dilution is generally not covered by non-recourse protection, which addresses credit losses rather than commercial disputes. The seller remains responsible for it.
What to check
- Track credits and deductions separately by cause and by customer
- Know your historical dilution before you talk to a factor; it often shapes the advance rate
- Agree on how and when deductions will be charged against your reserve
Industries such as consumer products, food and apparel often have meaningful dilution from retailer deductions. Clean records help separate valid deductions from ones you can dispute and recover.