Those who are new to factoring receivables generally want to know how much invoice factoring costs, and how it compares to other commercial financing options such as bank loans. It is important to learn about the cost of invoice factoring, including how that cost is calculated, before, of course, choosing to use account receivables factoring services. Not only will your business have to account for this cost in its budget, you will want to know as much as you can about invoice factoring costs in order to choose the best client invoices to submit.
Know Your Rate and Calculate Invoice Factoring Costs in Advance
Generally speaking, factoring companies charge a percentage or rate for the total amount of the invoice(s) being factored. It would be fair to estimate invoice factoring rates at 2-5%. These percentages, however, can vary widely; industry, volume, and speed of collection will greatly impact the rate and therefore the total invoice factoring cost. The fee structure or timetable may be arranged by day, week or even month depending on the firm.
Rates for Invoice Factoring Vary Widely so Shop Around
Invoice factoring companies each charge their own rates and fees depending on type, monthly factoring volume and the services that are offered. Expect to pay more for full-service concierge-level factoring where the factor provides back-office collection and accounts receivables duties. Some industries like construction and building, oil and gas, and government contract factoring may cost more because they are higher risk industries and are known for having longer payment timelines.
A local factoring company that only provides small-volume, small dollar amount factoring services to your specific industry, such as trucking and freight, might cost significantly less than large, nationwide firms that process a volume of $250,000 per month. In a nutshell, it is well worth your time and energies to shop around to find a priced-right factoring company that fits your business model.
Payment Timelines Dictate Invoice Factoring Costs
The general rule with account receivables factoring is that the longer it takes for the factoring company to collect actual invoice payment from the client, the more you can expect to pay. Payment is often charged on a weekly basis so the longer it takes to collect payment, the more you can expect to pay altogether.
For this reason, and this is true for most all factoring companies, you want to choose a client for factoring that always – to the best of your knowledge – pays their bills on time. This can help you manage the payment timetable and reduce expenditures so you can estimate in advance how much you will be paying in factoring fees.
How Payment Process Works for Factoring Receivables
If you are new to invoice factoring, it may take a bit of time to learn about how it all works. Here’s a brief overview of the process and rates.
- The factoring company agrees to purchase your client’s invoice valued at say $50,000.
- Your business receives 70-93% of that $50,000 in a few days.
- The factor retains the remaining 7-30% that is held in reserve until the client remits payment.
- This reserve, sometimes called the remainder, may be held and retained by the factoring company if the client fails to pay its invoice depending on whether you are using recourse or non-recourse factoring.
- Once the client remits payment in full, the reserve or balance will be unlocked and sent to you, minus the percentage or fees owed to the factoring company.
A reputable factor will provide your business with all rates and fees upfront so there are no surprises. Be leery of any factoring company that does not offer a fee table in advance.
Transparency Helps Reduce Cost of Invoice Factoring
Nowadays, many factoring companies offer an online account management system as part of their service that allows companies to access their reserve account at any time to see precisely when an invoice was paid. These online account management systems not only allow for faster payment processing, they allow businesses to verify they are charged correctly. Because your business can see precisely when your client paid its bill, the invoice factoring company cannot overcharge you by saying it was paid at a later date.
There may be other fees associated with factoring accounts receivables. Some charge an additional cost for each invoice they process. Others charge an application fee or a client verification fee. Again, it is wise to be mindful of these fees as they can add up. Any factoring company that is not transparent in their percentage and fee structure should be viewed with suspicion.
How Does Invoice Factoring Cost Compare to Other Options?
Account receivables factoring is a higher risk, alternative commercial financing option. For this reason using factoring services will generally cost you more than using lower risk options such as bank loans. If your business meets the qualifications – has been established for 3-5 years, has a long-term record of YOY profitability, has good-excellent credit, and more – it will probably cost less overtime to obtain a bank loan. Rates of small business loans can be between 1-3%.
If You Qualify, Bank Loans May Cost Less than Invoice Factoring
Though factoring invoices costs more than a loan, it costs less than other alternative financing options, such as merchant cash advances and working capital loans. Expediency is one of the main reasons businesses choose invoice factoring. Part of what you are paying for when you choose invoice factoring is the ability to get a large chunk of cash quickly – usually in a matter of days. Banks and other traditional lending options do not provide financing fast.
In today’s tough lending environment, however, it can be tough for many businesses to obtain a loan. This is why so many companies choose alternative funding options such as factoring. Though it may cost more, obtaining fast cash by factoring invoices can be a better option than not obtaining the capital you need to grow or sustain your business.