How to Understand Invoice Factoring Costs

Invoice factoring has been gaining popularity in Australia as tool to finance businesses that need to improve their cash flow. In this article, we help you understand how debtor finance companies evaluate your business to determine what factoring rates to offer. However, keep in mind that each factoring company has its own underwriting criteria.

What affects factoring costs?

Debtor finance and factoring companies determine the factoring cost for a client by by looking at the risk of invoice non-payment and at the client’s turnover (volume). To make this determination, most finance companies evaluate the following:

#1 Your turnover or volume of financing you are asking for

The most important variable in determining your factoring cost is the amount of financing that you are asking for. Factoring is no different from any other business that offers clients a discount for higher volumes.

It is not that other variables are not important – they are. However most other variables have a greater influence on whether an invoice is financed (or not) rather than on the actual cost of financing.

#2 The size of your invoices

Another important factor in determining your factoring costs is the size of your invoices. From a factoring company perspective, managing a factoring plan can be labor-intensive. Processing ten A$1,000 invoices is nearly ten times more work than processing a single A$10,000 invoice.

However, invoice size has an effect only if your invoices are relatively small because smaller invoices generate smaller revenues on a per-invoice basis. There would be little cost difference between processing a single A$100,000 invoice or ten $10,000 invoices because these are larger invoices that generate more revenues for the factor.

#3 The credit quality of your clients

The credit quality of your clients is often used as a tool to determine whether invoices should be purchased, rather than to determine the cost of the service. However, credit quality could influence your rate – somewhat – if your clients have exceptionally good creditworthiness.

#4 The number of clients you have

The number of clients that you plan to finance plays a role in your factoring rate. This variable is known in the industry as customer diversification. Factoring companies prefer to work with clients who sell to a large number of customers because this approach minimises risk. Clients whose sales are concentrated in a single customer are seen as riskier.

However, this is not a precise measurement. A client with a single customer who has excellent commercial credit may get a better factoring rate than a client whose multiple customers have only average credit.

#5 Your industry

Your industry plays a role in the rate that you get. Some industries are seen as riskier, from a financial perspective, than others. However, this view also has to do with the debtor finance company’s perception of risk.

One simple way to ensure you get the most competitive terms is to work with a factoring/debtor finance company that specialises in your industry.

#6 Your trade history and background

Lastly, the length of your trading history and background affect your costs – to an extent. Businesses with a long trading history and whose owners have ample industry experience get better terms than newer businesses that are operated by less experienced owners.

Type of Programmes

There are three types of factoring programmes: conventional invoice factoring and progress claim finance. Each of these programmes has a specific focus, set of features and cost.

Most invoice factoring plans require you to finance all (or most) of your accounts receivable ledger. These plans are very focused on volume and offer lower costs for higher factored turnovers.

Single invoice finance plans, on the other hand, allow you to finance an individual invoice. These transactions have a higher risk than conventional invoice factoring transactions. Therefore, their per-invoice cost is higher.

Lastly, progress claim financing programs specialise in financing construction subcontractors. The construction industry is seen as riskier – from a non-payment perspective – than other industries. Thus, progress claim financing programs tend to be more expensive than conventional programs.

For a more detailed explanation, learn more about debtor finance costs.

So, what is the cost of factoring?

The bottom line is that cost varies based on everything that we have discussed. However, service fees can range from 0.50% to 2.80% based on your turnover. Remember, the lower the turnover, the higher the fee. Additionally, a factoring discount of WILR + X% can be charged. This incremental (X%) is based on volume and industry. To get more precise information specific to your business, use this form.

Evaluate total cost rather than factoring rate

Keep in mind that your factoring rate can be very different from the total cost of factoring your invoices. For example, an invoice factoring plan may have a lower cost than a single invoice finance plan. However, if you need to finance only a few invoices rather than the whole ledger, the single invoice plan may end up costing you less.

Is invoice factoring right for your business?

Generally, a factoring plan benefits your company if the following are true:

  1. You work with creditworthy commercial clients
  2. Your gross profit margins are high (above 15% for low turnover volumes)
  3. You offer net-30 to net-60 day terms to customers
  4. Your biggest problem is that you cannot afford to wait 30 to 60 days for a payment

Need a factoring quote?

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