When it comes to improving cash flow and increasing the opportunities for business expansion, many businesses need invoice factoring services to grow at the pace they are after. For small businesses, invoice factoring provides the opportunity to get rapid cash advancements before a client pays an invoice. With many clients opting to pay on net terms, there can be a cash flow issue on the other end. To make invoice factoring work for you, and to get optimal factoring rates for your business, here are a few things you need to understand about invoice factoring rates.
What Is an Advance Rate?
Before considering invoice factoring rates, you’ll need to understand the advance rates that a factoring company can provide to your business. An advance rate is the percentage of an invoice that your business can receive from the factoring company prior to the invoice payment by your client. Generally, factoring companies offer anywhere between 80 to 90 percent of an invoice amount as an advance rate. The factoring company will pay out the remaining amount on the invoice once your client pays the invoice and the factoring company deducts the factoring fee.
What Is a Factoring Rate?
The factoring rate is the percentage fee that the factoring company charges to your business as payment for services. This fee is calculated as a percentage of the invoice, and it is the rate at which the factoring company charges your business while the invoice remains unpaid by your customer. Factoring rates can range from as low as 0.5 percent to 5 percent for up to 30 days.
Calculating Factoring Rates
To calculate factoring rates, a factoring company assess two major components: volume and risk. Businesses with higher volume and lower risk receive lower factoring rates. On the flip side, businesses with lower volume and higher risk receive higher factoring rates.
In factoring, “volume” refers to both the quantity of invoices your business submits to the factoring company, as well as the amount billed on those invoices. A factoring company prefers higher volume because it reduces administrative and processing costs. Greater volume can also be an indication of better business stability.
When it comes to risk, a factoring company looks at several key components that allow them to calculate the likelihood that they will receive payment for their advance.
Criteria for Invoice Factoring
Volume and risk broadly cover the key criteria that a factoring company takes into consideration to calculate a factoring rate. These criteria can be broken down into these 5 general categories for invoice factoring:
Volume of Factoring: The volume of factoring comprises the volume of invoices that your business submits to the factoring company.
Invoice Size: The invoice size is the amount on the invoice that your business submits for a factoring advance rate. The invoice amount is equal to the amount that your client must pay to you.
Business Type and Industry: A factoring company examines the type and industry of your business to assess the risks. The two major distinctions that a factoring company looks at in this regard is whether your business is a service-based or goods-based company. Service-based companies can usually receive higher factoring rates because the businesses have a shorter turnaround time to cover the costs of employment, and services cannot be returned. Other Goods-based companies might receive lower factoring rates because their profit margins have a higher gross, and issues such as returned products can dilute the invoice payment.
Client Credit Reliability: The credit of your client’s can affect the factoring rate that your business can qualify for. Although this is not a major component in determining a factoring rate, it does hold some importance, both for your business and the factoring company. Credit reliability can refer to the track record of on-time payments that the client has in their relationship with your company, but it can also take into consideration the overall credit history of the client. There are some clients that factoring companies will not consider providing advancements for if the client has a history of late payments.
Business Stability: Determining a factor rate also takes into account the stability of your business. Newer businesses, businesses with higher turnover, and businesses with lower client concentration will receive higher factoring rates. This is because the factoring company sees risk in the instability of a business. Vice versa, businesses with a lengthy history, solid trading record, and higher client concentration can negotiate for lower factoring rates.
Factoring Rate Period
The invoice factoring rate period can affect the factoring rate that your business qualifies for and can also play a part in determining the total factoring cost of a given invoice. The invoice factoring rate increases in direct proportion to the period of time for repayment. For example, a repayment period of 30 days might help to qualify the business for a factoring rate of 1.5 percent. But a repayment period of 60 days will result in a higher factoring rate.
The repayment period is also where the client credit reliability becomes a major factor for the costs of factoring to your business. The longer that a client’s invoice is outstanding, the more a factoring fee will be deducted from your overall returns on that invoice. So if you have a factoring rate of 1.5 percent for an invoice of $100,000, then the total amount of the invoice for which your business would be paid out would come out to $98,500 and the deducted fee would be $1500.
By understanding invoice factoring rates, you can get access to increased cash flow and flexibility for business growth. To learn how to make invoice factoring rates work for your business, get in touch with one of our expert consultants at Strategic Capital and find out how you can apply today!
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