To begin, it’s a common misconception that lower rates result in a lower overall cost. Lower discount rates and service fees do not always translate to a lower price per pound. To get an idea of the cost per pound.
For instance, your invoice is worth £1,000. Two separate factors offer you different rates. The first offers you 80% advance at a rate of 3% per 30 days. The second offers you 85% advance at a rate of 3% per 30 days. While the first has a cost of 3.75p per pound, the second offer costs 3.53p per pound, showing that despite having an equal discount rate, the two offers have differing prices.
Now that’s out of the way lets get to how factoring companies calculate the fees your offered and what factors matters.
Volume and size of invoices
The more invoices you offer a factor, usually the lower rate you’re likely to pay because an increased volume means a more consistent stream of revenue for the factoring company (meaning they can reduce the fee). In addition, owing to the factor’s credit control over your sales ledger, the facility becomes more cost-effective when it has more invoices to control.
On top of this, the larger the invoices, the better. Invoices with a larger value typically reduce the processing fees for the factoring company. Generally speaking, the lower risk your company represents and the higher the volume of invoices you want factoring, the lower the rate you will have to pay.
Industry
Some industries are riskier by nature. Labour-intensive industries such as construction tend to carry a higher risk, as there’s more to go wrong. Project completion dates change regularly, and there are lots of dependent variables at play in each project. This uncertainty translates into varying payment dates, which poses a higher risk for the lender. If the lender perceives your industry to be high-risk, your fees will reflect that.
Your trading history
Invoice factoring companies will want to see your trading history, complete with your financial statements. The less profitable your business, or the lower annual turnover it has, the higher the risk it represents to the lender, typically resulting in higher factoring costs.
Invoice payment terms
The longer your customers have to pay their invoices, the higher your fees. In practical terms the discount charge will be higher, discount charges typically work on a 30-day basis, meaning you may have to double or even triple them for 60- or 90-day payment deadlines.
It’s also important to note the longer the payment terms, the longer your lender has to wait to see their money returned. Lenders have to juggle their own cash flow, too, and the longer the payment period, the bigger this challenge – thus the higher the fee.
Recourse or non-recourse factoring
An invoice factoring agreement with recourse means that lenders are protected if your customers default on their payment. Despite invoice factors assuming control over your sales ledger, a contract with recourse generally means that you remain liable for non-paying customers. A non-recourse agreement means that your lender takes the hit if a customer cannot pay. Non-recourse contracts are more expensive, but the increased cost may be worth it if your invoices are typically large and you want to minimise your risk from non-paying clients.
A non-recourse clause is also known as Bad Debt Protection, where the invoice financier absorbs loss from customers who fail to pay (in effect a form of business insurance). Make sure to carefully check the wording if you agree a non-recourse clause to ensure it covers your business.
