Most businesses are going to turn to some form of lending in order to manage anything from short term cash flow issues to longer term capital needs. There are a variety of loans available from bank loans to peer loans. One type of lending is that where a company sells its invoices for payments due to a factor that, in turn, pays them the face value of those invoices less a fee.
Factors are also known as factoring companies. They do not lend money in the same way that banks and other lenders do. As such, invoice factoring rates can create some confusion.
Basically, the factor gives working capital to businesses when they purchase a set amount of receivables from that business. They do not lend money to the business at a particular interest rate, however. This is because they take a percentage for themselves at the time they buy the invoices.
This is a fee but it should not be confused as being the same thing as interest. If you are a business owner and you have $15,000 that a customer owes you in 30 days but you need the money immediately, the factor could buy it for $14,000. This is a made up scenario, but essentially, in order to get the money from the factor, the business owner has to pay them up front for this convenience.
Some factors will advance a portion of the amount in 24 or 48 hours. The invoice factoring rates, not interest, might be 3 percent of the face value. Some factors may also charge a fee per invoice. If a business owner has several different invoices due, they may need to pay $1.50 per each invoice factored.
The factoring company has to do the work of getting the invoice paid back to them. Since they will be waiting about 30 days to collect, they take their fee in order to cover their own expenses until they do collect. Factors will normally charge an additional percentage of the invoices when they go past the 30-day mark.
There is a risk involved for the factoring company. For example, the invoice may become a bad debt. For this reason, most factoring companies will also charge a sum to place on reserve. This amount may be refunded to the business owner once the account has been settled. However, each factor company is different.
Some companies charge as much as 20 percent for a reserve while others only charge 2 percent. It is important to note that once a business has established a relationship with a factor, the fees usually go down as the “credit” they have is demonstrated.
Get up front money and move a business forward with factors. The fees and charges vary, so it is important to shop around. However, these factor rates are not the same as interest rates. Factoring is a great option to traditional loans and this method of sourcing capital should be on every business owner’s list.