Opting for invoice factoring over other financing choices is only the first step. Once you have decided on non-bank financing to improve cash flow in your business, you need to investigate the cost of invoice factoring. Factoring companies charge different rates and fees, and you want to make sure your overall cost is the best value for the money you spend on cash advances.
How are You Charged Interest with Invoice Factoring?
There is often some confusion with the billing process of invoice factoring.You may see the term “factoring interest rates” and make an assumption that this is equivalent to the APR we associate with bank loans. That is not the case. With invoice factoring, the percentage mentioned is referring to the amount that is deducted from your invoices as payment.
For example, if you are asking for a cash advance on an invoice for $10,000 and the factoring company promises 90% upfront, then they are going to advance you $9,000. There are no factoring interest rates in the way there are with typical bank loans. With this type of cash loan for your business, you are not required to make payments over an extended period.
What are the Fees for Invoice Factoring?
Factoring receivables will require that you pay fees for the service. These are deducted from the amount of cash advanced to you, in a way you are getting a loan, but you have already paid for it. The factoring company will withhold a certain percentage of the invoice, not only to cover the fees but also as added insurance for them. Once they have received full payment from your customer, the balance (not including the fees) is transferred to you.
Why Do the Fees Differ for Invoice Factoring When Using the Same Service Provider?
A factoring company is lending money against your customers’ invoices. They will look at the credit history of those customers before agreeing to the transaction, and base the amount of the fee on their risk. This is not any different than a bank charging higher interest rates for applicants with lower credit scores. The more risk involved, the more you can expect to have deducted upfront.
Are There Other Considerations When Costs Are Determined for Invoice Factoring?
The non-bank lender is also going to take into consideration:
- The number of invoices you are asking to factor.
- The average dollar amount of those invoices.
- What the terms of the invoices are.
- How many days are left outstanding (DSO).
- Your specific industry.
What are the Average Factoring Rates?
Factoring companies will look at all of the above criteria to help determine their rate. A higher volume of invoices in a service-oriented business with shorter terms will typically get the best rates, and you could find yourself paying 4% or less for the entire transaction. If the payment terms of the invoices have already gone beyond 30 days, you may pay up to 7%, depending on the customer’s industry and credit history. Experienced factor lenders know that certain business types, such as large cable companies, regularly take longer to resolve individual invoices than other businesses.
The Fine Print in Invoice Factoring
Non-bank financial organizations that are advertising rates that seem too good to be true are usually not being frank about their practice. Low rates may only apply if you are factoring beyond a specific amount in invoices, or it could just be for a certain number of days. In that case, if your customer does not pay according to the terms stipulated by the factor, you could be charged extra. Be wary of factoring deals that seem too good to be true, and make sure to ask the right questions.
Factoring interest rates can vary drastically, not only from one company to another but with your invoices too. The important thing is to understand how the billing for this type of alternative financing works and choose a lender that gives you the best rates based on your circumstances.