What is the cost of invoice factoring?
Universal Funding’s factoring rates start as low as 0.55% and are usually no higher than 2%. There are many factors to consider when calculating the cost of invoice factoring. One of the many benefits accounts receivable financing is the value of turning your money more quickly and accessing working capital more readily.
Some Fintech companies offer an alluring 1% rate, but keep in mind this is a weekly rate, increasing by one percent each week. On a net 30-day payment, that rate is really 4% and on a net 60-day payment, it would be 8%. As you do your research on the factoring company that is best for you, make sure you ask about their terms.
We know that every business is different and deserves a customized financing program and we want you to get the lowest possible rate.
Factoring a $10,000 invoice at a weekly 1% rate would cost you $400 a day 30 and $800 by day 60. Universal Funding provides a monthly factoring rate. If you were to agree to a 1.5% rate, the same $10,000 would cost you $150 at 30 days and only $300 at 60 days saving 50% of what a weekly rate would cost you.
An example of the cost of invoice factoring
Let’s say you are in the custom golf cart business and it costs you $7,000 to produce one golf cart in 15 days. Your customer agrees to pay $10,000 for the cart, but needs 30 days to pay. That means you will go 45 days without payment to cover the cost of producing another golf cart. Once you get paid for the first golf cart and cover the cost of building a second cart, you have a $3,000 profit.
It takes another $7,000 and 15 days to produce the second golf cart and another 30 days to get paid. Now, a total of 90 days has passed and only two golf carts have been built and sold. Your total profit so far is $6,000—still not enough to build two carts at one to get ahead. At this rate, you’re turning your money every 45 days and can only produce nine golf carts per year, yielding $27,000 in profits.
Related: Is Invoice Factoring Right for Your Business?
How do you calculate the cost of factoring?
Let’s assume your business continues to grow thanks to invoice factoring. Now you are building 10 golf carts each month. Your customer is Gary’s Golf World and he agrees to buy 10 carts each month for $100,000 with net30 payment terms.
You are now working a factoring company and your terms are 1.5% for 30 days and an advance rate of 85% of your invoices. You decide to factor Gary’s invoice each month in order to continue to grow your business. Each month, upon verification of Gary’s invoices, the factor wires $85,000 into your account. Thirty days later, Gary pays the factor $100,000. The factor deducts their fee of 1.5%, or $1,500 and pays you the balance of $13,500.
Most people want to calculate the cost of factoring by multiplying the 1.5% rate by 12 months, which would be an 18% APR. But, that is how the banks operate. The invoice factoring rate is calculated by multiplying the factoring rate, which can range from 0.55% to 2%. In this example, the rate is 1.5% of $100,000 x 12 months = $18,000.
Related: How to Calculate if Invoice Factoring Will be Cost-Effective for Your Business
How can you offset the cost of factoring?
If you could be paid as soon as you deliver a product or servce, you could build a golf cart every 15 days for a total of 24 each year. With this model, you would turn your money 24 times a year with a profit of $72,000, while using $7,000 in working capital.
While that may seem like a large sum, how much do you pay your vendors by taking advantage of their 30-day terms? Many vendors offer 1% or 2% and sometimes up to 10% discount if paid within 10 days rather than 30 days. A 2% discount on a $7,000 invoice is $140. At 10 carts per month, you would owe the vendor $70,000, so that adds up to $1,400 per month and $16,800 per year. Compare that to the annual cost of factoring, which is $18,000. The money saved by paying your bills early is one way to offset your invoice factoring rate as well build credibility with your vendors.