How to Compare Different Factoring Rates?
For centuries, accounts receivable factoring has helped businesses speed up their cash flow. Factoring enabled business owners to sell their invoices for immediate cash instead of waiting for months for their customers to pay them. Today business people get paid upfront on their invoices faster and more easily than ever before, all without incurring debt.
When you explore today’s factoring options, you’ll want to ask about invoice factoring interest rates, which are also known as factoring fees. Whether you are looking at flat fee factoring or other programs, be sure to compare what could be called the true cost of factoring. It is important to understand the types of factoring fees and work out the cost of factoring from the various proposals you may receive from different factoring companies. Invoice factoring costs and factoring company rates will vary among companies, as will their services and levels of expertise.
Here’s a look at a few factoring cost programs and examples for comparison.
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. This cost of factoring receivables is popular for its simplicity. You can find that flat fee factoring is often available at factoring companies that serve the transportation industry, for instance. The process of factoring freight bills lends itself to a flat fee structure.
For example, when considering factoring costs, 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
The tiered factoring fee is based on a schedule that ties your fees to the number of days a factored invoice is outstanding before payment is received by the factoring company. This factoring fee is driven by how long it takes for your customer to pay.
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, such as in the following program:
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. When you’re exploring accounts receivable factoring rates, ask each factoring company’s specialists about tiered rates and average factoring rates.
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. This invoice factoring rate 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. The average factoring fees on this arrangement can be a bit challenging to formulate.
To calculate this type of factoring fees arrangement, the client first has to know the prime rate. The prime rate can be tracked on a number of websites (like bankrate.com) and found 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 the average days outstanding 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.
Factoring rates are different for different industries. For instance, flat fees do not always produce 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. An average factoring fee will reflect a number of variables based on typical factoring clients and a factoring company’s years of experience with factoring rates.
With a tiered factoring rate schedule, the accounts receivable turnover is less important. Even though you may be paying a higher factoring 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 an entire group 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. Businesses can look at average factoring rate projections while comparing programs and factoring companies.
Comparing factoring fees 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.