Factoring Fees Comparison: How to Compare Different Factoring Rates
Today business people wanting to get paid upfront on their invoices have a variety of factoring options. These options include different invoice factoring interest rates, which are also known as factoring fees. It is important to work out the cost of factoring from the various proposals you may receive from different factoring companies, so let’s get started.
The Flat Factoring Fee
The flat factoring fee is the simplest cost to calculate. The flat fee, also referred to as a fixed fee, is a flat percentage of the factored invoice amount. You can find that flat fee factoring is often available at factoring companies that serve the transportation industry, for instance.
For example, a flat fee of 2% means 2% of the invoice amount regardless of how long it takes for the invoice to be paid (usually up to a certain number days).
Invoice Size: $1,000
Flat Fee: 3%
Days Outstanding: (0-60 or 0-90, depending on proposal terms)
Fee: $30 always
The Tiered Factoring Fee
As the name implies, the tiered factoring fee involves a schedule that ties your fees to the number of days a factored invoice is outstanding before payment is received by the factoring company. A typical tiered rate schedule for this kind of invoice factoring fees program looks something like this:
1% of the invoice amount for invoices outstanding between 00-10 days
2% of the invoice amount for invoices outstanding between 11-20 days
3% of the invoice amount for invoices outstanding between 21-30 days
4% of the invoice amount for invoices outstanding between 31-40 days
And so on through 60 or 90 days
Invoice Size: $1,000
Days Outstanding: 39 days
Day ranges may be fixed or variable. Looking at the example above, you will note that the invoice factoring rate goes up by the same amount for each range of days. A tiered factoring fee schedule may also include different percentages and different day ranges, like this:
1.5% of the invoice amount for invoices outstanding between 00-30 days
2.5% of the invoice amount for invoices outstanding between 31-45 days
3.5% of the invoice amount for invoices outstanding between 46-60 days
4.5% of the invoice amount for invoices outstanding between 61-75 days
5.5% of the invoice amount for invoices outstanding between 76-90 days
In the above example, note that the first tier is 1.5%, but the rate goes up only 1% for each additional tier. Also note that the first tier is for 30 days and each additional tier is only 15 days when calculating the factoring interest rates.
As you can see, the tiered factoring rate schedule can be slightly more complicated than the fixed factoring fee, but it may in many circumstances this invoice factoring rate produces the lowest overall cost. Factoring company rates can vary across these tiers.
The Administrative Fee with Interest
The administrative factoring fee is not applied as much as it used to be, largely because factoring clients find it difficult to translate this factoring invoice rate and fee into dollars and cents. It involves what is usually a low flat fee (the administrative fee) plus a charge for the usage of the funds, payable with interest usually quoted as a spread over the prime rate.
To calculate this type of factoring fees arrangement, the client first has to know what the prime rate is. The prime rate can be tracked using a number of websites (like bankrate.com) and is also published in the Wall Street Journal. Let’s say that the prime rate is 3.25% per year. Therefore, prime rate + 3% equates to an effective annual rate of 6.25%. The effective rate floats as the prime rate moves up or down. Sometimes, the factoring company may have a floor and a ceiling on the effective interest rate, such as, “the effective rate shall never be lower than 5% nor greater than 15% per year.”
1.25% administrative fee per invoice plus interest
Interest: prime rate + 3% per year (floating)
Prime Rate: 3.25%
Effective Rate: 6.25%
Invoice Amount: $1,000
Advance Amount: $900 (90%)
Days Outstanding: 35 days
Administrative Fee: $12.50
Interest Charge: $900 outstanding at 6.25% per year = $.15626 per day x 35 days = $5.47
Total Charges: $12.50 admin fee + $5.47 interest charges = $17.96 total cost
To convert this type of factoring invoice rate quote into dollars and cents, one really has to have a good handle on what the average days outstanding are for all accounts one wishes to factor. Generally speaking, this type of rate quote can produce some very competitive rates, but factoring companies expect your receivable turnover to be at least 8 times per year (average 45 days outstanding or less). Most factoring companies will monitor this statistic and reserve the right to review or change your invoice factoring rates in the event of any adverse change in your accounts receivable turnover.
Let’s jump back to the statement about flat fees not always producing the lowest overall cost for the client. Based on the same premise that factoring companies want to see your accounts turning over 8 times per year, they will come up with a flat fee. If your actual turnover is slower, it costs the factoring company money, so they will build into the flat fee some “insurance” to protect their return.
With a tiered factoring rate schedule, the accounts receivable turnover is less important. Even though you may be paying a higher rate on slower paying accounts, the factoring company is usually willing to offer lower factoring rates for fast-turning accounts.
In the final analysis, it is your average factoring cost over the entire population of factored invoices that is most important. Paying a little extra for a few invoices often justifies paying a lot less on a large number of factored invoices. Understanding the differences in invoice factoring rates may take a conversation or two with an experienced factoring specialist. However, that understanding can help you save money in the long run.
The cost of factoring can be an excellent investment for your business when you partner with a company committed to helping you maintain your cash flow and grow your business. Interstate Capital’s factoring experts are ready to work for you! Get started today with a free factoring assessment.