What are the costs of invoice factoring?
Tuesday 4th October 2022
In this article:
- What are the costs of invoice factoring?
- What are the types of fees associated with invoice factoring?
- What is an example of an invoice factoring cost?
- What are the cost vs. benefits of invoice factoring?
What are the costs of invoice factoring?
Many invoice factoring providers base their fees on a discount rate i.e. the cost of borrowing the money. This works like a bank loan interest rate - the discount rate given is an annual fee; the actual rate charged is a daily rate for each day of borrowing.
Some finance providers offer a flat fee so regardless of the length of borrowing and how large or small the value of the invoices, the fee paid is one off and upfront.
Many factors are taken into account when a factoring company considers an application for finance based on the value of a company’s invoices. These will include assessing the success of the business and reliability of their customers.
Rates are often preferable for businesses dealing with small numbers of large value invoices. As the work involved in collecting an invoice is the same regardless of its value, selling lots of low value invoices is likely to be reflected in the higher rates charged. There are other charges that may apply – service and collection fees – that could impact on overall cost.
There are always fees incurred when raising finance this way and these will vary depending on the factoring company chosen. There are no standard costs for this service.
What are the different types of fees associated with invoice factoring?
Set up fee
This fee may be charged for the initial application. If a previous application has been successful then it may be waived or may be lower.
Service fee
The first invoice factoring charge you’re likely to come across is the service fee, which is the cost of having the facility in the first place. It’s usually calculated as a percentage of your turnover, and the percentage is likely to change depending on the turnover too, so there can be fairly significant differences in costs here.
Invoice factoring fees are most likely to vary between providers. In most cases this fee is payable monthly and is agreed either in monthly periods or on a rolling agreement.
Factor fee (discount fee)
This is a processing fee for each invoice that the factor company has to process. It is usually a percentage of the value of the invoice, so with a small number of large value invoices this fee may be lower than for a company dealing with lots of low value invoices due to the extra work involved. The rate charged is usually within the range of 1.5 – 5%. Fees are often negotiable and regular reliable customers may receive more favourable rates.
Additional costs
There can also be additional costs that will vary from lender to lender. In some cases there might be charges to end the agreement early, because some are agreed over fixed terms. There might also be additional services added on to the package that have other costs associated with them too, and in some cases there might even be an arrangement fee. Always make sure you know exactly what you’re looking at when making comparisons, because hidden costs can quickly add up.
Find out how much invoice factoring would cost your business using our calculator
What is an example of an invoice factoring cost?
You have an invoice due in 30 days for a value of £10,000.
Your cash flow will struggle to cope as you have to wait 30 days to receive payment and you need to pay staff. You decide to factor this invoice to a factoring finance company.
The lender you choose offers you a discount rate of 2.5% and a service fee of 1%. You will receive 85% of the value of the invoice immediately with the rest received on completion of payment by your customer.
You will receive 85% of £10,000 immediately = £8,500.
The service fee is charged on the whole (gross) amount of £10,000 = £100 (1% of £10,000).
The discount rate is an annual rate and is 2.5%.
As it is an annual rate, the daily rate charged is 2.5%/365 = 0.00685% and will be charged for each of the 30 days that the money is borrowed for. This is only charged on the money that they pay upfront, £8,500.
0.00685% x £8,500 x 30 = £17.46.
So the total cost of borrowing £8,500 for 30 days is £100 + £17.46 = £117.46.
What are the benefits vs. the cost of invoice factoring?
There are many benefits to raising financing through invoice factoring though consideration of benefits versus the costs is important.
Without factoring there are no costs incurred but time waiting for payment can be costly due to the effects of lack of cash flow in the business.
The benefits of invoice factoring include:
- Improved cash flow - Lack of cash flow is one of the main reasons that many businesses fail. Even with a well selling product maintaining a healthy cash flow in business can be a challenge.
Invoice factoring allows cash to be raised immediately, improving cash flow and control of finances.
For a small company or one that is finding managing its finance tricky, this can be a beneficial way to remain afloat and to keep its business operations running, providing cash to invest in new opportunities, improving turnover and profit. - Reduction in labour costs - By handing over the administration involved in processing invoices labour costs can be reduced and time freed for more effective use within the business
- Flexible financing - Invoice factoring is a flexible form of finance and is likely to be a cheaper way of accessing cash than a bank loan.
