In return for receiving the value of your unpaid invoices immediately, you will pay a factoring company a factoring rate (1%-5% of invoice value) which accumulates the longer the invoices remain unpaid, plus a service fee.
There is no standard rate for these fees. Rather, the factoring company will offer you a rate based on your company situation and the value of the invoices you want to factor.
This is explained in more detail below. We will cover:
- What debt factoring is
- What the advance and the rate are
- How debt factoring costs are paid
- How debt factoring is recorded in your company’s accounts
A Quick Introduction to Debt Factoring
Invoice financing is when one company buys debt from another. Most commonly, it comes in the form of factoring or invoice discounting. Your company may have an invoice that is currently unpaid, but you can still receive money from this by factoring (ie. selling) it with a third party (a bank or specialist lender).
Factoring your debt is a safe and reliable way to raise capital and can help smooth out cash flow issues. This can work to the advantages of businesses large and small.
Debt Factoring Fees Explained
The advance is also called the prepayment.
Before you understand the fees, you should understand what an advance, or prepayment, is:
The debt factoring prepayment is the percentage of your debt that the factoring company will pay you. In other words, it is the money you initially receive for your unpaid invoices. It might be between 80% and 95% of your invoice value.
The factoring company will return the balance of the invoices when they have been paid by your customers, with the following fees deducted.
The Factoring Rate
(The factoring rate is also called the discount rate)
The factor rate is calculated on a weekly or monthly basis. The longer it takes for your client to pay the full value of the invoice (the “factoring period”), the more you will pay for factoring that invoice.
If you are factoring a large value of invoices, you are more likely to be offered a low factor rate.
Example low factor rate: 1% of invoice value annually
Example high factor rate: 5% of invoice value annually
The Management Fee
(The management fee is also called the service fee)
The management fee is an administrative fee that is expressed as a percentage of your annual turnover. This would be paid for every year that you are using their invoice factoring facilities.
Remember that your factoring company is not only buying your invoices, they also take responsibility for invoicing your customers, credit management and debt collection, and take on administrative costs.
Example low management fee: 0.2% of annual turnover
Example high management fee: 2.0% of annual turnover
Depending on the factoring company, other fees may apply:
- Transaction fees
- Overdue fees
- Early termination fee
- Credit check fees
- …and others
It is a good idea to company the market with a broker like FinCred CF to ensure you are getting the best possible terms.
An Example Cost of Debt Factoring
Here’s a rough example to demonstrate the potential costs involved in invoice factoring:
Your company has unpaid invoices totalling £10,000. Your company turnover is £100,000.
FinCred CF could help arrange an agreement with a factoring company for 95% of the invoice value:
- The factoring rate is 2%
- The service charge is 1%
You receive £9,500.
The factoring charge is £180
The service change is £1000 per year, or £83 per month.
The total cost to you in one month is £263.
There is a £500 difference between the value of your invoices and what you received. At the end of the month, the factoring company will pay you £500 – £180 – £83, or £237.