Most people use a simple approach when comparing proposals from competing factoring companies. They make their decision based on who offers the lowest rate and the lowest application fee. While this strategy is common, it can lead to making a wrong decision. This is because the lowest rate does not always equal the lowest cost, nor is it always the best proposal.
In this article, we teach you the best way to evaluate the cost of factoring proposals. Use this strategy to determine which proposal offers the most cost-effective solution.
Factoring proposal components
Let’s first examine the financial components of a factoring proposal. The components are:
- The advance: the initial amount that the factor gives you for your invoice
- The discount: the fee – or rate – that the factor charges you
- Ancillary costs: additional expenses that the factor may charge
- Application and due diligence fees: the cost of reviewing your application and setting up an account (used by some)
While all of these components affect your costs, the ones with the greatest impact are the advance and the discount. Consequently, you should focus on these two components. If you need detailed information about factoring, read “What is invoice factoring?”
Which proposal is the best one?
Let’s evaluate some factoring proposals. We start with a simple comparison and build up to something more complex. Of these two offers, which one is a better deal?
- A 70% advance at a rate of 3% per 30 days
- An 80% advance at a rate of 3% per 30 days
Obviously the second option, the one with the 80% advance, is the better deal. You get a higher advance for the same rate as the other proposal. Let’s review a more complex scenario:
- An 80% advance at a cost of 1.5% per 15 days
- An 80% advance at a cost of 3% per 30 days
This is more difficult to evaluate since we use different rate time frames. Arguably, one could say that they are the same, since they both have a rate of 3% for 30 days. Realistically, option 1 is better because it breaks the rate down into smaller time increments. Like the first example, you don’t need complicated math to figure out which one is better.
Let’s move on to an example that is more complex, and more realistic. Which proposal costs less?
- A 70% advance at 3.00% per 30 days
- An 80% advance at 3.35% per 30 days
This one is not as easy as the previous examples. You might be inclined to think that option 2 is more expensive, since it has the higher rate. But keep in mind that it also offers a higher advance. Actually, the second option has a slightly lower “cost per dollar” than the first option. Technically, it is the cheaper one. Cost per dollar is an effective way of comparing factoring costs that helps you make better decisions.
How to calculate the cost per dollar
In the previous example, we determined option #2 is cheaper because we compared each option’s total cost per dollar, rather than just comparing their rates. The total cost per dollar gives you the financing cost for each dollar you get in the advance. This is the best way to compare costs.
To simplest way to calculate the total cost per dollar of a proposal is to divide the rate by the advance. Here’s a quick math lesson: remember that 80% is entered as 0.8 in your calculator and 3.35% is entered as 0.0335. Divide 0.0335 by 0.8 and you get the cost (in cents) per dollar. However, you can make meaningful comparisons only if the rate is for the same period of time. This table shows the results:
Advance Rate | 30-Day Factoring Rate | Cost per Dollar | |
Option 1 | 70% | 3.00% | $0.0429 |
Option 2 | 80% | 3.35% | $0.0418 |
How to evaluate proposals
The most effective way to evaluate a factoring proposal is to follow these four steps:
Step 1: Ask the factoring companies to submit their rates using the same format and time frame
Ask the factors to submit their rates in the same format. Getting terms in the same format will help you make meaningful comparisons. This step takes some discussion and negotiation with each factoring company. However, most factors will agree to this request.
For example: if you want your pricing on 30-day increments (as in 3% per 30 days), ask each factor to submit the pricing using 30-day increments.
Step 2: Create a table and compare costs per dollar
Create a table, ideally with a spreadsheet, that compares the cost per dollar of each proposal. The following table is an example of a spreadsheet that evaluates multiple proposals, all of which charge a 30-day rate.
Which option offers the best deal? The answer depends on your situation. If you can live with a 75% advance, company B offers the cheapest cost of funds. If not, then company D may be a great deal because it offers a higher advance than the others but is cheaper than companies A and C. Using a table, you can make an educated and intelligent decision regarding who offers the lowest total cost per dollar.
Step 3: Compare all the extra costs
Use a table similar to the one used in step 2 and list all the extra costs that each company charges. Keep these costs in mind when making a decision. They may affect your decision in cases where the costs per dollar are very similar.
Step 4: Cost is not everything
In most cases, the pricing difference between factoring companies is small. Keep in mind that cost is only one of the many things you need to consider when selecting the best factoring company. There are other variables, outside of the proposal, that you should consider. These include the firm’s longevity, experience in your industry, and references.
Get a factoring quote
We can provide factoring lines with high advances at low rates. For more information, get an online factoring quote or call (877) 300 3258.
Disclaimer: This post is for informational purposes only and does not provide legal or financial advice. Numbers and calculations are not guaranteed to be accurate or representative.