The important point to understand about receivable factoring is : the advanced funding you receive for your receivables and the discount fees you will pay are based solely on the financial strength and credit worthiness of your customers, not your business. Discount rates will also vary depending on the total dollar amount you intend to factor on a monthly basis (volume discounts apply). Having said that, it is also important to understand that specific rates or fees for factoring your businesses receivables cannot be promised or quoted without knowing anything about your customers, your business, or the invoice amounts you wish to factor.
If you go to a factoring web site, you will find that some factoring web sites are advertising a seemingly low discount rate that is presumed to be the rate any business will get if they factor with them. Be careful and understand that this may a term of a ploy and is only a baited hook to get you on the phone. Once they have you on the phone and review all of your receivables it is only then you will learn the real factoring fees they intend to charge you.
Here are some examples of how the fees and funding can work for receivable factoring. If you are interested in receiving an exact quote for factoring your invoices, then you want to fill out a “getting-started” form that provided by a factoring company. It could be very simple to a complex one. Then, a factoring specialist will contact you for a “should—free—consultation” to tailor a factoring solution and fee structure that best fits your business.
- Advanced Funding: When you send in an invoice to be Factored you will usually receive between 70% and 90% funding of the invoice amount within 1-2 working days after the invoice has been verified (depending on the invoice amount and the business paying the invoice). This is your advanced funding. Advanced funding is usually wired to your business bank account.
- Discount Rate = Factoring Fee: The Factoring fee can range between 2.5% and 3.5% per 30 days, or .1% per day the invoice is unpaid after factoring. Keep in mind that factoring fees are usually tailored to the individual needs of your business and customer base.
- Length of Time for Payment Sample Discount Rate: Per day=0.1%, 30days=3%, 45days=4.5%, 60days=6%, 75days=7.5%, 90days=9%.
- Remainder of the Advance minus the Factoring Fee: When your customer pays the invoice you will receive the remainder of the advanced funding, minus the Factoring fee (discount rate).
Fee and Funding Calculation Case example
Lets say you have a customer XYZ Company that owes your business $100,000 for a shipment of your product just delivered. XYZ Company is a large customer that has good credit but they never pay their suppliers (you) any sooner than 45 days. Instead of anxiously waiting 45 days to get your $100,000, this time you decide to use Factoring to improve your cash flow.
The Factoring company verifies your invoice to XYZ Company and you receive 80% of the $100,000 ($80,000) within 1-2 working days, wired to your bank account. If you have a discount rate similar to the sample shown above and XYZ Company pays the $100,000 invoice in about 45 days, this equals a factoring fee of 4.5% of the original $100,000 ($4500). Since you have already received an advance of $80,000 from the factor, you will receive the remaining $20,000 minus the factoring fee of $4500 ($15500). Therefore, in the end you collected $95500 of the original $100,000 invoice.
However, this time you did not have to wait the usual 45 days to get your money. This time you received $80,000 up front in 1-2 working days, and collected the remaining $15500 in 45 days.
The discount rate for factoring services is a composite of several elements.
Most factors will require you to sign a contract which acts as a security agreement. The contract outlines as below:
- The financial terms of the agreement: This includes the amount you receive up front, the discount rate, and how often you will use the factor’s services in the allotted time.
Your collateral. Factors consider your accounts receivable as your main source of collateral, but may also do a blanket lien against all of your company’s assets.
- Default provisions: This covers fraud, non-payment, and various circumstances to ensure the factor gets paid. You will then have to satisfy the debt by paying the invoice out of pocket or providing a substitute invoice of equal or greater value.
Make sure to read the contract carefully to make sure there isn’t anything that looks questionable:
- Are the advance rates and fees clearly spelled out?
- Do you see any hidden or ambiguous fees?
- Will you have to factor a certain number of invoices?
Having a lawyer review the contract can be a good idea since this arrangement significantly affects your company’s revenues.
Contract lengths varies based on your needs. If you only need occasional factoring services, you can get a month-to-month agreement. If you will depend on frequent factoring services, a six-month or one-year contract will provide you with more leverage for negotiating a better discount rate. Some factors may require a contract even for one-time factoring. It maybe a good practice if you keep the contract is an open-ended agreement. This will save you from paying duplicate set-up fees if you need to factor in the future.
You may want to read the following sub-topics too:
A basic explaination about receivable factoring.
Types of factoring available in the market place.
Learn what advantages and disadvantages of factoring are.
Basic knowledge about funding process of a factoring.
A considerable guidance on how to choose a right factoring company to meet your need.
Additional worth consider tips for factoring buyer.
Jargons commonly used in factoring world.