A common concern among factoring prospects is the cost offactoring receivables.Unfortunately, there’s no “one-size-fits-all” rule when determining the cost of factoring services. Despite the teaser rate advertised by a factoring company, the final cost for you will depend on the terms ofyour factoring agreement, which are based on your company and client portfolio characteristics.
An abundance of confusing information about invoice factoring exists online; we’ll try our best to clarify and organize it for you.
So, how much do factoring companies charge?
Factoring companies generally use any of two fee models to charge for their services:
- The first model consists of just one all-inclusive fee.
- The second one usually includes invoice factoring fees and factoring account fees.
It’s essential to understand how the fees are applied. For instance, you may find that the single-fee model ends up costing your company significantly more in the long run. We’ll provide comprehensive information so you can understand all the elements that influence the cost of factoring and also learn how factors (or computer algorithms in some cases) evaluate your company before defining your rates and fees.
Your learning process begins here. Let’s talk about accounts receivable factoring fees.
What are Factoring Fees?
Factoring fees are the discount factoring companies receive for purchasing invoices before they are due and waiting for debtors to pay them.
These fees are calculated by applying a factoring rate on the amount advanced or the invoice face value depending on an agreed-upon rate structure.
For example, a 1% rate on a $100 invoice costs a $1 factoring fee if applied to the invoice value and $0.80 in fees when applied to an 80% advance.
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Factoring fees begin accruing on the day the receivable is purchased and are usually collected by the factor when the invoice is paid.
Here is a simplifiedfactoring fee example:
- Invoice face value: $1,000
- Amount advanced: $800
- Factoring rate: 1%
- If calculated onamount advanced= $800 x 1% = $8
- If calculated oninvoice value=$1000 x 1% = $10
We’ll show you more realistic examples of common factoring rate structures and factoring discount rate calculation details later on this page.
What are Invoice Factoring Rates?
Factoring rates (or factoring discount) are the discount charges used to calculate factoring fees.
There are several rate models. The most popular options are a “flat discount rate” (for example, 1% every 30 days) and a “flat discount plus margin” (for example, 0.5% every 30 days plus PRIME+2% interest rate).
The invoice factoring rate that your company will be offered mainly depends on:
- The model the factoring company uses to structure its discount rates,
- The risk level of your company and your clients, and
- The amount of invoices you plan to sell each month.
This section will help you understand how factoring rates are usually structured.
Factoring companies use several parameters to structure their discount rates. Understanding these structures is crucial when evaluating factoring agreements. We will now describe and exemplify the two most common approaches.
Let’s say you are selling a $100 invoice that will be paid in 60 days. You have been offered an advance rate of 80%.
Let’s see how factoring fees will be calculated using the two most common methods.
Click here to learn about factoring advance rates.
Typical Factoring Fees & Factoring Discount Rate Models
Flat Factoring Discount Model
In this model, commonly used by the new wave of online lenders, fees are calculated by applying a rate on the gross invoice value instead of the amount advanced.
Example:Let’s say you’ve been offered:
A 2% Flat Discount Rate for the first 30 days and an additional 1% Flat Discount Rate every 30 days afterward.
The fee on your $100 invoice, if it’s paid in 60 days, would be:
First 30 days: $100 *2% = $2.00
Second 30 days: $100 * 1% = $1.00
Total factoring fee=$2+$1 =$3
Here is a simple Factoring Flat Discount Calculator for you to input your numbers and see how it works.
Flat Discount Calculator Instructions
This script will calculate the factoring fee for the period the discount rate covers (e.g. 1.5% for 30 days). If you have more than one period/rate you’ll need to make separate calculations. (e.g. in our example you’ll need to calculate first 1.5% for the first 30 days, then 1% for the second 30 days and then add the results). Complete fields entering numbers only.
Flat Factoring Discount plus Margin Model
Most factoring companies use a combination of a flat fee and an annual interest rate to define their discount rates.
- Example: Let’s say that your factoring discount is:
- PRIME + 2 %,
- Plus a flat discount of 1.00% every 30 days.
Your $100 invoice, if it’s paid in 60 days, will pay the following fees:
- First, a PRIME + margin fee
PRIME6.25% annual
PRIMEdaily rate= 6.25% /360 =0.017%.Thisis calculated on the amount advanced, not the gross invoice amount, so we need to calculate your advance. Advance amount = $100 *80% = $80
The part of your fee based on prime plus marginwould then be: $80 x 0.017% x 60 days =$0.84
- Second, a flat discount
Theflat discount for 60 dayswould be $100*2.00% =$2.00 - Lastly, let’s put them together
Totalwould be $0.84+$2==$2.84
Note:Prime rate is the short-term interest rate (annual) used in the US banking system. We use a Prime Rate of 4.25% in this example.
Here is a Factoring Flat Discount and PRIME plus Margin Calculator for you to input your numbers and see how this rate structure works.
Factoring Flat Discount and PRIME plus Margin Calculator Instructions
This script will calculate the factoring fee for the period the flat discount covers (e.g., 1% for 30 days). You’ll need to make separate calculations if you have more than one period/rate. (e.g., in our example, you’ll need to calculate the first 1.0% for the first 30 days, then 1.00% for the second 30 days, and then add the results). Complete fields entering numbers only. No $,%, etc., characters are allowed.
The options described above represent the most common factoring agreements. However, these are not the only ones. Before picking a factoring company, you must thoroughly read and understand a factoring proposal, review the numbers, and consider other important variables.
What Factoring Rate Can Your Company Get?
Generally, you can expect to pay from 1 to 4% of the invoice amount factored as invoice factoring fees.
Whether the receivable factoring company uses a flat discount, prime plus a margin, or another model to structure the factoring discount,your offered rate will depend on your company’s risk level to the factor.
Aspects that influence your company and clients’ risk to a factor
Many factors influence your factoring discount rate. The most important ones are the following:
- Your company’s average collection period (days sales outstanding)
- The concentration rate of your portfolio of customers
- Your company’s sales volume
- The creditworthiness of your customers
Customer Concentration
As part of the factoring approval process, a factoring company needs to analyze your client portfolio and the percentage of businesses each client represents to your company. The decision maker will give special attention to the customer concentration ratio to measure the risk of doing business with your company in case of an account default.
Let’s see how this works:
A company with just one customer has 100% concentration. A decision maker will likely find this situation extremely risky because if something unfavorable occurs with this customer, your business will suffer. Unless this single customer is a highly reputable and creditworthy business, it is improbable that a factoring company will offer you a deal. If it takes the risk, your discount rate will likely be higher and a lower advance rate.
As a general rule, the more customers you have and the more evenly your sales are distributed among them, the lower the customer concentration and overall risk. Companies with low customer concentration tend to get better factoring rates than those with high concentration.
Here is a simple calculator if you would like toestimate your company’s customer concentration.
Important Note: As with most variables used to calculate your business risk, customer concentration is a relative factor. Only a deep analysis of your portfolio can help a factoring company make a final decision. For example, if you have a high concentration but your main customers are companies that the receivable factoring company qualifies as low risk, this high concentration rate may have no influence in establishing your invoice discount rate.
Days Sales Outstanding (DSO)
Day Sales Outstanding (DSO) is your company’s average collection period.
As a general rule, the shorter the time it takes to collect a customer’s invoice, the lower the risk of default and the lower the discount rate your business may qualify for.
Results vary according to your business’s field of industry. However, a DSO under 1.5 times your payment terms is usually considered a good result.
Here is a simple calculator to help youestimate your company’s DSO.
Volume
The amount of accounts receivable your company plans to factor every month will significantly affect your factoring discount rate. Factoring companies incur several costs to set up and manage your account, many of which are almost the same whether you sell invoices for $10k or $100k.
As a general rule the more invoices you plan to sell, the lower the rate you will likely pay.
Author: Marc J Marin
