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Of all the criteria you consider when choosing an invoice factoring service, the company's rates and fees likely have the most significant impact on your choice. Of course, you need to consider other items, such as the level of service the factor provides and their time in business, but understanding the cost helps ensure you get the most out of your accounts receivable. This is because the fees that your factoring company charges can really eat into your profits. In addition to the main charge levied for advancing payment on your invoices, many factors charge extra fees, some stated clearly and others that are more difficult to determine.
The two most common fee structures are tiered and flat fees. Coming in a distant third is prime plus, rarely used by factoring companies today.
This is the most common fee structure, with charges accruing according the particular factor's schedule. Some accrue monthly while others operate on a weekly or daily basis, or even in 15-day blocks. For you, the most attractive tier is either daily or weekly.
So, how does this tier work? Let's say the invoice was for $1,000. The factor advances 80 percent, with the remaining $200 to be paid, less the factor's fees, once your customer pays the invoice. If the invoice is due on the 30th of the month, and the custom pays on the 15th, your fee includes the entire month, even though they paid 15 days before the invoice's due date. If the tier is daily or weekly, though, your fee includes only the time the invoice went unpaid, meaning you keep a larger chunk of that remaining $200.
Most factors charge a monthly rate, but they may still calculate fees on a daily or weekly basis. Make sure you verify exactly how the tier structure works before entering into an agreement.
Next in terms of commonality is the flat fee structure, which is also the simplest to comprehend. It's exactly what it sounds like: the factor charges a flat percentage of every invoice, regardless of how long your customer takes to pay.
You see this rate structure most often in industries where payment is more reliable, such as trucking and transportation.
This is rare today, but you may find a factoring company that charges prime plus. This is a variable rate, as it changes whenever the prime lending rate does. Prime is the interest rate that banks charge customers with the best credit rating. As of September 2017, prime was 4.25 percent.
The "plus" part is the extra fee charged by the factoring company. This means that, if the factor charges prime plus 3 percent, your rate would 7.25 percent, or $7.25 for every $100 invoiced. Interest accrues daily until the invoice is paid, so you want customers who pay quickly to help lower the fee you pay.
The one thing true of financial products across the board is that there are usually extra fees. These vary by factoring company, but the most common additional fees include:
- ACH fees: Sometimes called bank wire fees, this fee covers the charge levied by banks to transfer funds from the factor's account to yours.
- Application fees: You may also see this as a startup fee, and it's meant to reimburse the cost of processing your application and activating your account. Typically, the factor waives the application fee until processing your first invoice, but some do levy this charge up front.
- Early termination fees: If you signed a contract and then want to cancel it for any reason, you typically must pay a fee to do so.
- Monthly minimum fees: If your billing doesn't meet the factor's monthly minimum (assuming it has one), you must pay the difference.
- Processing fees: Also known as invoice processing, this covers the cost of processing your invoices, including record maintenance and credit checks.
- Servicing fees: You may see this listed as administration or maintenance, but whatever the company calls it, it's a monthly charge intended to cover miscellaneous expenses related to your account.
Fees vary not only among factory companies but also within the same company. The factor looks at particulars about your organization when proposing its fee structure, including:
- Your industry: Certain industries present a higher nonpayment risk than others, which leads to higher fees. If you are in the construction industry, for example, your customers are considered a higher risk. You may get a better rate from a factoring service that specializes in construction. The medical industry is considered extremely high risk, so much so that most factoring companies won't work with them. Healthcare providers typically must use factors that specialize in the medical industry.
- Your customers' creditworthiness: Just as your credit rating determines the interest your bank charges for a car loan, your customers' credit score determines the fee charged to factor their invoices. The more reliable and creditworthy your clients, the lower your rates.
- Your company's stability: The longer and more stable your financial and credit history, the better your rates.
- Invoice volume: The more invoices you send, the harder the factoring company has to work. Therefore, you get lower rates if you send fewer invoices for larger amounts. Instead of sending multiple invoices to a single client every month, send as few as possible to help improve your rate.
- A continuing relationship with your invoice factor: Many factoring companies charge lower rates for continued business. This is because, as their familiarity with your business and client base grows, their job becomes easier.
Invoice factors may include clauses in their agreements that allow for the adjustment of fees if your billing volume changes. For example, if the amount you invoice every month increases significantly, you may enjoy a drop in your factoring fee.
To get the best rates, obtain quotes from multiple companies. Also, don't be afraid to negotiate. Once you sign on the dotted line, you're locked into that rate, so take your time and do your research.
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