No matter the size of your business, unpaid invoices are undoubtedly a part of your reality. A healthy cash flow is essential to running your company successfully, and outstanding invoices hinder that success.
Invoice factoring is one solution that can ensure your business has the cash it needs to move forward. But before choosing a firm to collect your payments, you want to select one that fits your business needs and offers the lowest invoice factoring rates.
This article will give you all the basic information you need to know about factoring rates to make an informed decision.
What is the cost of invoice factoring?
Selling your invoices to a factoring firm to collect payment for you within 30 to 90 days can run anywhere between 1% and 5% on average. The factoring rates are determined by the invoice amount, how long it takes your customers to pay, and your sales volume.
There’s also a client assessment performed to determine their creditworthiness. Typically, the larger your monthly amounts, the lower your factoring rates will be, and many factoring companies have volume discounts available.
3 common factoring rate terms explained
Factoring companies use three different structures to calculate your factoring rates. Choosing the best one depends on your industry and the time it takes your clients to pay.
Flat Rates: These are one-time upfront payments charged by the factoring company. No matter how long the invoice remains unpaid, the factoring fee doesn’t change. This option is popular in the trucking industry.
Variable Fees: A variable fee structure means a small percentage is discounted for as long as the invoice is unpaid. The longer your client takes to pay, the more you’ll be charged in fees. For example, the factoring company charges 3% for the first 30 days and an additional 0.5% for every 15 days the invoice remains open. Those fees are called invoice discounting rates.
Advance Rates: Factoring advance rates are when a large percentage of the invoice is given to you upfront, and the rest is held until your client pays the invoice. The factoring rates for advances differ from industry to industry. The medical and construction industries are viewed as risky and harder to fund, so most advances range between 60% and 80% at most. Businesses that provide general services can expect to receive between 80% and 90%, while the transportation industry sees the highest advance rates between 92% and 97% at most.
How is invoice factoring client risk determined?
Since the factoring company essentially takes on your client as their own, they have a few ways to determine the risk being taken on your behalf. Your risk factor will decide your eligibility as well as your factoring rates. Below are the major aspects that influence the factoring company’s decision.
Length of time in business
The length of time you’ve been in business is one of the risk factors taken into consideration. Before a factoring company can trust your invoices, they need to trust that your business is legitimate.
Since the credit check is performed on your clients and not your business, factoring companies are taking on quite a risk if you’re fairly new to the industry. For that reason, your factoring rates will usually be higher than a business that has been in your industry for several years.
Total monthly revenue
How much revenue are you bringing in every month? That is a question factoring companies are sure to ask when assessing your risk.
The higher your monthly revenue, the more of a discount you may receive on your factoring rates. It gives the factoring company confidence that your invoices are being paid promptly, which is music to their ears.
Time it takes your customers to pay their invoice
Factoring companies will examine your clients’ payment history when calculating the risk of taking on your invoices. Therefore, if your clients often make late payments, the factoring company will view them as high risk. The factoring company will assume they’ll also receive payments late and are less likely to take on your invoices.
Factoring companies need to know that your customers are reliable and will ask questions about your client’s reputation and credit scores. Debt or legal issues that can prevent clients from paying and the industry they represent are important aspects factoring companies consider.
If you conduct business with government agencies and companies with good long-standing reputations who are known to make on-time payments, you stand a good chance of being picked up by a factoring firm.
Number of customers
Conducting business with a wide variety of customers shows the factoring company that you’ll stay busy hauling freight in any season. That is a good sign of your business’s overall health and will likely net you better factoring rates.
How long are invoice factoring rate periods?
Invoice factoring rate periods are the amounts of time allotted for customers to pay their invoices, and they directly affect the factoring rates your business is charged. The fees increase proportionately with the time set for repayment.
For instance, if your clients make their payments within 30 days, you may qualify for a factoring fee of 1%. However, if it takes them 60 days or more to make the repayment, your factoring rates will be higher.
If the invoice remains open after the factoring rate period ends, you will have to repay any advances you received for the payment. The factor usually deducts the amount owed from the available funds you have on hand.
Can I negotiate better invoice factoring rates?
Negotiations are a part of doing business, and that also applies when looking for the lowest invoice factoring rates. Carriers and owner-operators find negotiating for better rates very frustrating and time-consuming. Many brokers don’t want to budge and stand firmly behind their fees, which can be a little high for an upstart carrier.
It helps have a solid knowledge of factoring rates and an understanding of how fees are determined and which services your business needs. You can then enter negotiations confidently.
This way, you can also rest assured that you’d be able to settle on terms that work for you and the factor. Be sure to always read the fine print, as negotiating better factoring rates may mean entering into a longer-term contract, which may not be a part of your business plan.
How can you offset the cost of invoice factoring?
Here are a few actions you can take to offset the cost of invoice factoring:
- Take on more loads with cash flow from factoring for a volume discount.
- Accept routes closer to home.
- Factor the invoices of customers who paid early or on-time.
- Use profits to take advantage of early payment and volume discounts for raw or bulk materials.
- Wait 5 to 10 days before factoring your invoice. Clients with pay cycles greater than 30 days can now be customers who pay within a 30-day period.
- Don’t offer early payment discounts.
- Negotiate and renegotiate terms for factoring rates.
Secure your business’s financial future with factoring
Your business needs cash to flow smoothly, whether paying employees, vendors, or bills on time. Factoring is a sure way to secure your cash needs for those clients who take 30 to 90 days to make their payments.
By having the cash upfront, you’ll be able to take advantage of opportunities when they arise. You won’t have to miss out on a situation that could turn your company around simply because you were waiting for a large payment to come through.
So, consider your business needs and which factoring structure will work best to successfully receive compensation on your invoices!
FAQ
Invoice factoring is calculated by multiplying the total value of your invoices by the factor’s advance rate, typically between 80-90%, to determine the amount you will receive upfront.
No, you don’t have to factor every invoice. The decision of which invoices to factor is usually at the discretion of the business owner.
Some disadvantages of invoice factoring include potentially high fees, reliance on your customers’ creditworthiness, potential damage to customer relationships, and loss of control over your business’s cash flow.
