The art of factoring is simple. So years ago, factoring companies had to come up with some way to make it complicated and hard to understand. They did so through pricing.
Here are the basic variables of pricing, why factoring companies use them, and how they can impact you.
Factoring rate (discount rate): Expressed as a percentage, and applied to the face value of the invoice, this is the amount the factoring company charges each time an invoice is factored. If the rate is 3% and the invoice is $10,000, the factoring fee is $300. In a traditional “flat rate” transaction, this rate is fixed and it covers all the factoring company’s costs, including financing, staff, postage, supplies, accounting, administration, overhead, writeoffs, and profit.
- If the extra income generated from the added cash flow is more than the 3% added cost, then factoring has value for you and you should consider it. Otherwise it may not be the best solution for your business.
Adjustments for “turn” and volume: Factoring companies may adjust the factoring rate up or down based on how quickly the invoices are paid, or “turn.” The rate might also be adjusted for the total dollar amount you factor, usually on a monthly basis. These adjustments should be clearly stated in the security agreement. In many cases, the adjustments can be significant, so the client should study the agreement and be diligent to take advantage of the adjustments whenever it makes sense to do so.
Effect of reserves: Many factoring transactions are done with reserves, meaning the factoring company holds back a percentage of the invoice until after it gets paid by the end customer. In general, the greater the reserve, the lower the factoring rate, since the factoring company is advancing fewer funds and is taking on a lower risk. If you are looking to reduce your factoring rate and can manage without maximizing cash flow, ask your factoring company for a higher reserve and a lower rate.
Effect of term agreements: Factoring agreements can vary from month-to-month to two years and more. As a rule, the longer the agreement, the lower the factoring rate. To experience factoring before committing for the long haul, request a short-term agreement, then lengthen it after you’re convinced that factoring works for you.
Added fees: This is where you must be extremely diligent to avoid turning a productive tool into an expensive burden. Factoring companies can be very creative in managing income by reducing the factoring rate while adding all sorts of other fees. Be careful to ask about them and scour the security agreement before signing. Here are some of the more common fees:
- Postage and handling: per-invoice fees can include copying, mailing, filing, etc.
- Application fees (one-time)
- Setup fees (one-time)
- Error fees: for client and/or end-customer errors
- Credit checking fees: for credit requests
- Attorneys fees
- Method of payment fees: ACH, wire transfer, etc.
- Default fees
- Early termination fees
There are many pricing elements and variables available in invoice factoring. Get ahead of the game and structure a deal that works for you.
To get your questions answered, contact a Riviera Finance representative in your area today.