Tools are represented by a series of facets. This is to reduce the data processing required. (The illustrations below are 2D simplifications, actual tools, such as ballnoses, may have 3D profiles):
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Normally the facets are arranged to minimise the approximation error, so the representation is both inside and outside the actual tool profile.
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With 'Use Interior Faceting' checked, the representation is wholly within the tool profile, and the points coincide with '3 o'clock',' 6 o'clock' etc.
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The 'interior faceting' will give a more accurate simulation in 2D situations where cuts are orthogonal, when the cutting will be 'on the points':
