Factoring is the process of selling accounts receivable to a third party at a discount. This allows the business using the factoring facility to access the money earlier, which can aid in cashflow. A business comparing difference factoring quotes needs to consider both the service fee and the interest rates charged. There may also be other fees and charges to consider.
Most factoring quotes are for a relatively simple service. The factoring company pays a business a sum of money in return for taking over the rights to receive payments from clients. The sum of money will be lower than the total amount outstanding. Depending on which perspective you look at it from, this difference is either the costs the factoring company incurs in chasing up the debts, plus its profit, or the price the business pays to get immediate access to the money.
In the majority of cases, factoring quotes come with two components. The first is a service fee. This can be a set fee that is a percentage of the company's turnover during the duration of the service. Alternatively, it can be a set percentage of the actual value of the invoices included in the sale.
The rate at which the service fee is calculated can vary immensely. It can be as little as a fraction of 1% to as much as 5% or more. Generally, the variation reflects the complexity of the services the factoring company offers. It may be higher for businesses in industries where clients are considered less prompt and reliable payers, thus increasing the likely workload.
The second component of factoring quotes is an interest charge. This is usually based on the prevailing bank rates, such as the Fed Funds rate in the United States, plus a set percentage. The calculation of the interest charge can appear confusing, but in effect, it is charged as if the business were borrowing the money from the factoring company for the time that elapses between the factoring company taking over the debt and collecting the money from the client.
Not all factoring companies charge in this two-component way, so it is important to check terms carefully. Some operate on an advance and fee basis, which breaks the invoice total into three components. The first component, the advance, is the money the factoring company pays up front. The second, the remainder, is the money the factoring company pays the business when it collects the debt from the client. The third component is the fee, which is kept by the factoring company. An example set up would be a 90% advance, a 3% fee and a 7% remainder.
There are some other potential charges that may come on top factoring quotes. Some factoring companies will only chase up payments for 90 days, after which they may demand the business return the relevant amount. Some companies will also charge an additional fee if the business has a lower total invoice amount than was expected when the factoring company agreed its quote.
