Factoring Theoretical Framework, Factoring Cost

Factoring is a financial technique where a specialized firm (factor) purchases from the clients accounts receivables that result from the sales of goods or services to customers. In this way, the customer of the client firm becomes the debtor of the factor and has to fulfil its obligations towards the factor directly.

In a factoring arrangement, there are three parties directly involved namely; the one who sells the invoice (client), the debtor (customer of the seller), and the factor (financial organization).

• Seller of the product or service provider who originates the invoice is called Client and generally is a business firm.
• Debtors or customers of the client are the recipient of the invoice for the goods or services rendered. They promise to pay the balance within the agreed payment terms. They owe the money for the value of goods and services bought from the seller.
• Assignee (the factoring company) or factor is the service provider who purchases the invoice and gives advance payment to business firm.

Factor is thus an intermediary between the seller and buyer. Mechanics of Factoring shown in figure is explained below:

Steps in Factoring Service

• Firstly, the customer places an order with the Client
• Client sends goods and invoice to customer
• Client assigns invoice to factor
• Factor make pre-payment up to 80 % to client
• Factor send statement to customer
• Customer make payment to factor
• Factor makes balance 20% on realisation to client.

Cost:

Flat Rates vs. Variable Fees

Factoring companies typically calculate rates using a variable fee structure. With variable fees, they discount a small percentage (1 to 3 percent) of the invoice for as long as the invoice goes unpaid. So, the longer your customer takes to pay, the more you’ll pay in fees. A factoring company may charge 2% for the first 30 days and 0.5% for every 10 days that the invoice remains unpaid. Fees are often referred to as invoice discounting rates.

Some factoring companies offer a flat fee structure where a one-time fee is charged up front. With a flat fee structure, the fee remains the same no matter how long the invoice remains open. This type of rate structure is common in the trucking industry. Depending on your industry, one or both of these options may be available and can help you control your costs.

Invoice factoring fees also depend on whether you choose a recourse or non-recourse factoring program. Non-recourse factoring poses more risk to the factoring company, so the costs are slightly higher.

Advance Rates

When your company factors invoices, you’ll typically receive a large percentage of the invoice up front and the remainder is held in a reserve until your customers pay the invoice.

Factoring advance rates vary by industry. Industries that are riskier and harder to fund such as medical and construction can expect advance rates between 60% and 80%. Advances for general businesses and staffing companies can be anywhere from 80% to over 90%. Those in the transportation industry typically see the highest advance rates, ranging from 92% to 97%.

We recommend getting quotes from multiple factoring companies to get a good feel of what you should expect to pay for factoring services and to get the lowest invoice factoring fees for your business.

Factoring cost vs. Factoring rate

Businesses that are in the process of choosing a factoring company often focus their negotiation efforts on getting the best the rate. Although a competitive rate is important, it is only one component of your factoring cost.

A better alternative is to focus negotiations on the “Total cost per dollar” of the proposal. This approach helps ensure you pay the lowest amount for each financed dollar. To calculate the total cost per dollar, you need two figures. You need the rate and the factoring advance.

In most cases, you get the best deal by negotiating the lowest possible rate at the highest possible advance. This assumes you are looking for the highest possible advance, which is the case for most business owners. Otherwise, adapt your strategy accordingly.