The costs of invoice factoring
Invoice factoring costs
- Factors advance a percentage of the total invoice balance and withhold the rest for a set period.
- Fees are based on a percentage of the total amount of invoices factored.
- The perceived risk of the industry sector can influence charges.
- Factors evaluate credit scores for your buinsess and for the businesses invoiced.
- Companies can be charged other fees and penalties set in the factoring agreement.
Businesses sometimes sell off their invoices to a third party to get immediate payments for delivered goods and completed services. This is known as invoice factoring. Companies can use factoring to get quick cash when needed to keep the operations moving smoothly, or to maintain a predictable cash flow each month.
The costs involved in doing invoice factoring can vary widely, however, so it is a good idea to understand the charges. This starts with understanding the basic cost of the factoring agreement.
Invoice factoring costs
With invoice factoring, the factoring company advances a certain percentage of the invoice balance for a fee. Once the invoices are collected, or after a set waiting period specified by the agreement, the factoring company will release the rest of the funds to the company.
That factoring company may, for example, offer to advance 70 percent of the invoice amount at a fee of 3.5 percent, or alternatively 80 percent of the advance at 3.75 percent. Additional charges can be added to the tally depending on how long it takes for the factoring company to collect on the invoice. Now, your company has to decide which of these two offers represents the better deal.
In this case, assuming no differential in payment-collection times, the first scenario offers a lower interest rate and, on a pure cost basis, it is the better deal. That’s because the company is advancing you a greater percentage of the invoice amount in the second scenario, and you are paying a higher interest rate on top of it. Still, if you need access to more cash for your business operations, paying a little higher fee to get access to more money might be worth it.
Factoring charges can vary in other ways as well.
Invoice factoring is used in a wide range of business sectors, but the charges can vary by sector depending on the perceived repayment risk. Across all business types, the factor fee normally ranges from 1.5 percent of the overall invoice balance to 5 percent or more. Some sectors, like medical billing, are considered riskier and can start at the higher end of the fee matrix.
Likewise, the amount that a factoring company is willing to advance upfront often varies by sector and can range from 60 percent of the invoice total up to 90 percent or more.
Factoring companies also will often look carefully at the credit scores of a potential customer and the businesses being invoiced by that potential customer. This will often influence the factoring company’s charges and how much the company is willing to advance.
Companies may tack on additional fees and penalties for performing credit checks and performing due diligence, or if the invoice balances don’t meet the minimum threshold amount established by the factoring agreement. In some cases, factoring companies also may charge a premium for offering a nonrecourse factoring program, which is riskier for the factoring company because it will have no legal recourse to pursue a client if its customers default on invoices.
The bottom line is that a factoring agreement can come with many different charges. It is important that your company understand these fees to assess the costs and benefits of factoring your invoices, and to find the best deal for your company.