Loss reserve

The advance rate assumes the pool will mostly collect. The loss reserve covers the part that will not. It is sized off the pool's own default history, stressed to a multiple that gives the lender comfort through a downturn. Unlike a static haircut, a dynamic loss reserve moves every month with your portfolio's performance, which is exactly why lenders like it and why borrowers need to see it coming.

The key ratio is the default ratio: receivables that hit the agreement's default definition in a month, commonly invoices moving into the 91 to 120 days past due bucket plus write-offs, divided by sales in the month those receivables were originated. Most agreements then take the highest 3 month rolling average of that ratio over the last 12 months as the loss ratio.

A common formulation is: loss reserve = stress factor x loss ratio x loss horizon ratio. The loss horizon ratio is cumulative sales during the loss horizon, the period from when a receivable is originated until it is deemed defaulted, divided by the net receivables balance. It answers the question: how many dollars of sales are still in the window where they could go bad?

Notice the leverage in the loss horizon ratio. A company with fast turning receivables carries a high ratio of sales to outstandings, so even a modest default ratio produces a meaningful reserve. Definitions of the default trigger and the horizon vary by agreement, so use your document's terms.

• Counting invoices as defaulted when they age into the trigger bucket but ignoring recoveries, or the reverse, depending on what the agreement actually says.
• Mixing dilution into the default ratio: a credit memo on an old invoice is dilution, not a default, and double counting it inflates both reserves.
• Using calendar month aging when the agreement measures from due date, which shifts invoices between buckets and moves the peak ratio.
• Missing the peak: the loss ratio is usually the worst 3 month average in the trailing 12, so one bad quarter stays in the reserve for a year.

Olycor computes the default ratio, loss horizon ratio, and reserve from invoice level aging and write-off records, using the exact bucket and horizon definitions configured for your facility. Every month's reserve is reproducible: same inputs, same output, with each ratio traceable back to the invoices that produced it.