Many business owners attempt to compare APR interest rates to invoice factoring rates. The problem is twofold. One, the best factoring company’s rates include Accounts Receivable Management, Credit Services and Credit Protection and two, a bank only helps the most creditworthy company with typically 3 years of proven profitability.
We now explain the basic factoring process in simple terms for you to understand how it works and what it would cost you.
What is a Factoring Advance Rate?: A factoring advance rate is the percent measure of the amount you receive (usually by wire transfer or ACH) in cash when factoring invoice(s). Advance rates typically range from 80% to 90% of your invoice amount. This means if you factor an invoice for $100,000 you are typically advanced or $80,000(80%) or $90,000(90%).
Your factoring advance rate is the most critical number when looking at factoring costs, more important than the fees. Why? The reason you are factoring is to improve your cash flow. The advance rate needs to be high enough to cover your cost of goods sold. Otherwise, the benefit of using factoring for your cash flow issues would not be available to you.
Why do some company get 90% and others 80%? The exact advance rate that a company will receive mainly depends if they are a service-based company or goods-based company. For example, staffing companies typically achieve some of the highest advance rates up to 90%. You can’t return “labor” and your people and the costs associated with employees need to be paid weekly. Companies providing goods would be closer to 80%. They typically have higher gross profit margins (20-40%) and invoice payment dilution issues such as returned products and manufacturer marketing fees.
How do Factoring Fees Work? How you are charged for the duration the invoice is unpaid by your customer is the second most critical number. Your volume of business done with the factoring company, your client concentration (having very few customers) and the creditworthiness of your customer(s) is the main determining factor of this number.
Keep in mind a factoring fee is not an APR or interest rate. Many times business owners are confused and apply interest rate formulas to factoring, but it simply does not work that way. A factoring fee is similar to how your credit card might charge a monthly or daily set fee to have the account open. This is similar to how a factoring fee works. It is a percentage of the invoice amount. A factor applies a percentage of the invoice amount as their fee to you, which is as low as .79-2.29% for up to 30 days.
Let us look at the example invoice factoring arrangement below:
Your nursing staffing agency has an outstanding invoice for $100,000 from an excellent quality customer. The only problem with your customer is their payment term of 45 days. You are a staffing service based company with good, creditworthy customer. This will earn you a 90% advance rate. Most of your expenses are payroll and it is important to make sure you have working capital consistently flowing in to pay your temp nurses and payroll taxes, suta, futa and workman’s comp premiums.
Once the $100,000 invoice is verified, your nurse staffing company receives a same-day wire transfer of $90,000 into their bank from the factoring company.
You are charged a fee from the factor which varies depending on the length of time your customer takes to pay. For example, your fee is 1.5% for first 30 days an invoice is outstanding. In this case, your fee would be $1500. Your customer pays in full within 30 days and you are wired the remaining balance minus the $1500 fee. In this scenario, you received $98,500 out of the $100,000 original invoice and got 90% of its upfront for a $1500 fee. There are other minimal fees such as wire transfers. See Other Fees below.
Here is a chart of possible factoring fees based on Time Frame:
|Length of Time for Payment||Invoice Factoring Rate|
Keep in mind that a good factoring company will work with you based on your customer’s payment history and make sure your terms are favorable to you. See Time Frame below to learn more.
Time Frame: Your customers pay in a certain pattern. If your customers all pay in 37 days, then a fee based on 30-day increments would be slightly more costly. That’s because you will end up paying additional fees based on the extra 7 days. At Businesscash.com, we can design your fees based on your unique situation – daily, 10-day increments, 60-day flat fee, etc.
Other Fees: A Factoring Company can charge you for wire transfer, credit checks, unused line fees, early payment, monthly minimum fees, just to list a few. Like banks and credit card companies, factors can get creative with their fees. Businesscash.com aims to keep these to a minimum.
Unearned Factoring Reserve Retained: With client concentration or dilution issues, a factoring company might retain a percent of your reserves or balance after the initial cash is advanced to you. Let us look back at the example above, if you were advanced $90,000, your unearned reserve equals the balance or $10.000. If there are no issues (such as product returns) or unpaid fees, you will get the $10,000 minus the factoring fees once invoices are paid.
Earned Factoring Reserve Released: A factoring company will wire you the Reserve Retained. How often a factor releases your earned reserve will impact your total cash flow. Do they release weekly on paid invoices or on paid batches of invoices? Knowing how your monies are released is critical and also affect your cash flow needs and rate.
How does Invoice factoring rates compare to Merchant cash advance or ACH loans? MCA Loans can be 4-10 times more expensive with onerous terms! Please visit a blog from Paragon Financial for more information.
We firmly believe in treating our clients fairly and giving them the best and easiest ways to understand fees at Businesscash.com.
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