Trying to calculate the true cost of factoring can be a daunting task. There are many variables that are used to determine the factoring rates that you receive. Your industry, business age, and average invoice amount among many others are variables taken into account. It’s often times so complicated, that after hearing a sales pitch from a factoring company, you still may be asking yourself “How much does factoring cost?”
You should do everything in your power to answer that question because It can be easy to get lured into an agreement that looks good at first sight. If you aren’t careful, it won’t be as appealing once you crunch the numbers. This guide should help answer your questions regarding factoring rates.
What are the main variables that affect factoring rates?
Knowing the answers to a few main questions will help give you a general idea about what category your business fits into, and what types of factoring rates you can expect to receive.
The industry you are in
Businesses in all types of industries use factoring to free up capital, but some are considered riskier than others. The following types of businesses are considered risky and are prone to paying higher factoring rates:
Businesses that are in less labor intensive industries, such as Trucking, Third party logistics (3PL) and Staffing can expect to receive lower invoice factoring rates.
The size of your receivables
The size of your invoices can affect how much factoring will cost. Larger receivables are preferable because it will cost your factoring company the same amount of time and money to process a $25,000 invoice as it will to process a $250,000 invoice.
The amount you are planning to factor
This is similar to the last point that we made. As in virtually any type of business, you will receive discounts as you plan to do more volume. Because factors enjoy low overhead costs, they are quick to provide a slightly lower rate as incentive to factor higher dollar amounts.
The type of factoring you need
The actual factoring service that you use will also play a role in determining the your cost of factoring. For example, nonrecourse factoring will typically cost more than the recourse version. Read more about the different types of factoring.
Your customer’s credit
The creditworthiness of your customer can determine your invoice factoring rates. Though, if your customers have a poor credit history, they may not be factorable at all. This is one of the only variables that is in your control. You should still perform your proper due diligence prior to extended credit to your customers.
Your business history
A factoring company will extend the best invoice factoring rates if your business shows a long history of stable sales. New businesses, or those with low or unpredictable sales can be risky in the eyes of a factor. Seasonality can also lead to higher rates, though factoring companies know that it is unavoidable in certain industries.
What is my factoring rate? vs. How much does factoring cost?
At first glance, these two questions may seem the same. But they are vastly different. Not knowing the difference can land you in a less than ideal arrangement. But fortunately for you, we’ll explain the difference! Don’t worry, it’s simple.
Your factoring rate is the actual rate that you pay per transaction, or per invoice factored. For example:
Example #1: A flat rate of 4% per invoice.
Option #2: 3.5% per invoice, with an additional $15 fee per invoice.
How much does each option actually cost? Say that all of your invoices are always for $3,000. In that case, both options would cost the same. For example #1, 4% of $3,000 is $120. In the case of example #2, 3.5% of $3,000 is $105. Add in the $15 per invoice fee, and it also comes to a total fee of $120.
All of your invoices won’t be the exact same amount in realty. So if your invoices are typically less than $3,000 it would make sense to go with the first example. A trucking company or freight broker would factor invoices of these amounts in many cases.
Consequently, if your typical invoice is in excess of $3,000 it would make more sense to go with the second example. Construction companies that are looking for factoring would fall into this category, as each of their invoices are generally larger.
Navigating the world of factoring can be confusing. It’s important to understand what variables will have an affect on your invoice factoring rates. It is also important to know the difference between the rate you are paying, and the actual cost of factoring. While the above example was very basic in nature, it should provide you with a basic understanding of the difference. Feel free to share the rates you have been able to secure for your business in the comments below!