Invoice factoring has grown from being a largely unknown business finance option to a popular way of improving cash flow without getting into long term debt.
However, a lot of users don’t know that much about it – particularly the cost. While it’s often a more affordable form of finance, that’s not always the case.
It pays to dig a little deeper to understand exactly how much invoice factoring costs.
Factoring rates can drive up the cost of finance considerably, and there are a range of ways rates are influenced. Be clear on exactly how much using invoice factoring will cost from the beginning and read through the agreement in full to ensure you don’t get hit with unexpected charges.
Invoice factoring – widely used in cash flow solution
Invoice factoring helps businesses to improve cash flow by essentially providing prompt payment of invoices. Many businesses have to wait a month or more for customers to settle their accounts, all while covering running costs from their own bank account.
By selling invoices for cash now, businesses are better able to meet costs and invest in their own growth.
There are a few different forms of invoice-based lending; invoice factoring is just one. Invoice financing, discounting and accounts receivables (AR) financing are other names for borrowing – some are essentially the same, while others are slightly different. As with invoice factoring rates, often it depends on the provider.
Read more: An overview on invoice financing
Understanding factoring rates
Receivables factoring rates are not the only cost of borrowing. The total cost of factoring includes any additional fees that you’ll be charged.
Factoring companies commonly charge a combination of account, subscription, membership, administrative and other fees that can add up significantly over a period of time. Many factoring providers don’t charge interest on lending, but some do. Late fees can be significant too.
Invoice factoring rates can be determined by a range of features. For businesses looking into factoring, it’s often worth researching a few different options to find the best value for money, but also to see why different arrangements come with different price tags.
The cost of any business activity is important, and getting a deep understanding of exactly how much it’ll cost is one of the crucial things to know about invoice financing.
Five types of factoring rates
The average invoice factoring rates tend to be around 5-10% of the value of the invoice with all fees considered, but the way lenders arrive at the cost can differ dramatically.
There are four common types of invoice factoring rates that providers charge.
Flat fee factoring rate
The easiest fee to figure out, a flat fee rate is a one-time cost for the borrowing. The fee is the same regardless of when you pay back the loan, which makes it easy to budget for and manage.
Split fee factoring rate
Split fees start with a flat initial cost that increases incrementally after set periods of time – usually in 10 or 15 day blocks.
For example, the fee may be 5% of the invoice if it’s paid back within 15 days. Every 15 days after that, the fee increases by 1%.
Plainly, the faster you can pay back the balance, the cheaper the finance will be. This form of factoring is best suited to businesses whose customers pay invoices promptly.
Daily fee factoring rate
As the name suggests, a daily fee is calculated every day the borrowing is outstanding. Pay attention to the rate of fee increase – it often increases by the same amount each day, but it doesn’t always.
This form of factoring can be even cheaper than split fee factoring for businesses who can pay it back quickly.
Prime plus factoring rate
Prime plus rates tend to be better suited to businesses with large receivables, as it can end up acting like a more traditional form of business finance.
Rates are calculated daily, and comprise a prime rate on top of a base annual rate. For example, if the prime rate is 3% and the base rate is 4%, the total rate will be 7%. Prime plus rates often have administrative fees as well.
This is where things can get interesting. Almost all providers with charge a range of other fees. This can significantly drive up the cost. Some fees will also lock you in or will still be charged even when you don’t need the finance. These fees can include large establishment fees, administration fees, system fees, collection fees, early repayment fees, invoice submission fees, fixed monthly fees and late payment fees. Check the fine print to know your true cost! It often pays to go with providers that charge one simple fee.
How does risk, volume, time and size of your advance affect your rates?
Invoice factoring typically comes in two stages – the first amount is the advance you will receive – usually between 75-90% of the invoice value. The second amount is the leftover balance once the customer pays the invoice (less factoring fees).
Accounts receivable factoring rates can depend on your advance in four key ways:
- Risk. If you’re deemed a risky borrower, you’ll pay a higher rate than someone who poses less risk.
- Volume. A small, one-off borrower is likely to be charged a higher rate than a long term borrower seeking finance for multiple large invoices.
- Time. How long it takes to repay the finance. This often comes down to how long it takes customers to pay their invoices, though it’s an inexact science. If you’re able to choose which type of AR factoring rate to use, look into the data to see how long it typically takes customers to pay their invoices and test how that will impact your rate.
- Size. What proportion of the invoice do you want advanced? The higher the advance, the higher the rate you’ll pay.
As a borrower, you may not be able to negotiate terms and rates with the factoring service. However, if you’re going to be a long term customer that will generate good business for the lender, then you’ll have more power to arrange a cheaper rate.
Understanding how factoring fees are applied in a business
There’s no “right way” of applying factoring fees, though the more reputable providers will be happy to provide a breakdown of what rates represent and what you’re actually paying for.
It may not be everyone’s idea of fun, but it’s worth reading factoring agreements to fully understand what you’re agreeing to.
Ask factoring providers about what fees they charge, how much they are, and when they’re payable. There may also be hidden fees that aren’t expressly included, but that drive up AR factoring rates.
Additional fees can include:
- Documentation fee. A one-time fee charged at the beginning of an agreement to cover account creation and due diligence.
- Non-recourse guarantee fee. Recourse refers to who has responsibility for chasing unpaid invoices. A non-recourse means it’s the factor’s responsibility to ensure invoices are paid.
- Early termination fee. Factoring companies often require businesses to sign up for up to three years, which allows them to lower the cost of their service. Ending the agreement early can cost extra – though the absence of an early termination fee may mean your business is obligated to see out the contract in full.
- Late fees. Late fees can be significant, so take the time to understand the penalties if an invoice isn’t paid on time.
- Account fees. These can be called many different things, but are essentially membership fees due at the end of a given period.
Take home message
Accounts receivable factoring rates can vary from one provider to the next. Whatever the arrangement is, ask for a clear breakdown in exactly what you’re paying for.
While the benefits of invoice financing for businesses are clear, you should be clear on how much it’s costing to realise those benefits.
For a flexible invoice financing solution that doesn’t incur regular fees, check out FundTap. FundTap has no system, admin or account fees, it’s free to open an account, and businesses are only charged for invoices you submit to be financed.
With only a single fee that starts from 4% of the invoice value, FundTap helps to keep the cost of borrowing down, while empowering business owners with a cash flow solution that’s available when you need it.
Find out more about how FundTap works today.
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