Most companies seeking factoring financing try to focus their negotiating efforts on getting the best rates. However, most prospects fail to realize that the rate is only one component of the total cost. Most importantly, “rate” does not equal “cost.”
The role of the factoring advance
One critical component of the total cost is the factoring advance. It is not unusual for companies to offer a lower rate in exchange for a lower advance, which essentially keeps the total cost per dollar the same. As a result, a better way to evaluate a proposal is to look at the total cost per dollar.
This article discusses how both the rate and the advance work so that you can be in a better position to negotiate a factoring contract. Most basic factoring transactions have three components:
- Advance: The amount that is paid upfront. It usually ranges between 70% and 85% of the value of the invoice.
- Rate: The cost of the transaction. It’s usually expressed as a percentage.
- Rebate: The remaining 15% to 30% (less the factoring fee) advanced to you after the customer pays the invoice in full.
In most transactions, the advance is paid immediately after the work is completed and invoiced. The rebate, less the factoring fee, is provided when the customer pays the invoice in full. The transaction structure is very important because in order to get the lowest possible cost of funds per dollar, you need to have a combination of the lowest possible rate at the highest possible advance.
Negotiating lower rates
In our view, the most effective way to negotiate a lower cost of funds it is to outline all the details of the transaction and then determine the role that each components plays. This outline usually includes the advance, the rate, the rebate, and any reserves and ancillary fees. Once you have completed this exercise, make sure to negotiate each and every point in order to ensure a favorable outcome. Negotiating just on the rate won’t always provide the lowest cost of factoring.
Note that this article only covers the factoring rate, the advance, and the rebate. Many factoring companies offer more complex proposals with other variables to be negotiated.
If you are currently evaluating factoring companies, you may also want to read “How to compare factoring proposals“.
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Disclaimer: This article oversimplifies the complex matter of negotiating the cost of business financing. It does not intend to replace the advice of a financial or legal professional. As a matter of fact, we encourage you to seek financial and legal advice from competent professionals who are familiar with your circumstances.