The cost of factoring will depend on the company you deal with and the contract you sign. Costs are typically only 10% – 20% of the value of the invoice. When looking at the cost of factoring, it is worth remembering that your company might otherwise be paying staff to administer payment collection, so weigh the cost against the savings. If your business were to encounter problems it is important to remember that the factor will be as keen to recover their losses as any other creditor.
Costs to Consider
Factoring is never charged at a single, flat rate, so it is worth looking at the different costs involved. There is usually an initial fee for starting up an arrangement, and some kind of termination fee for ending it. Other feels will be tied to the invoices sold and number of transactions. Some of these costs may also depend on the company’s turnover, or interest rates. Costs may include some or all of the below:
- Startup or arrangement fees – around 1% of the potential facility
- Service charge or transactional fee – 0.5% - 3% of money put up by the factor.
- Annual review fee – usually 1% of the size of the facility available
- Ad hoc charges
- Termination charges
Startup or Arrangement Fees
Startup or arrangement fees can go two ways - either the factoring company offers a free trial, in which case the startup fee is either zero, (but may be deferred), or there’s a standard initial cost. The startup fee is usually based on 1% of the gross value of the outstanding invoices, so could be levied on outstanding payments that do not end up being collected on your behalf. This fee is a way of paying the factor to do its due diligence on both your company and the clients with outstanding invoices.
There are also two extra costs that are not paid to the factor, but are startup costs nevertheless: your company’s administration costs for supplying documents etc, and any relevant legal fees.
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Service or Transactional Charge
Service or transactional charges are usually calculated as interest on the money paid to your business for the outstanding invoices, not the potential funds available. So, if a factor pays 80% of an outstanding invoice, the rate on that may be a flat fee of 0.5% - 4%, or tied to a variable rate. Sometimes, a minimum service charge may apply. Because transactional fees can be either fixed or variable you will need to be completely clear about how they are calculated. Variable rates usually follow the base rate of interest but if the factor is a major financial institution, then they may follow their own overdraft rate, or the LIBOR.
Annual Review Fee
The Annual Review Fee is charged in the 13th month of working with a factoring company. It can be understood as a fee for the continuation of the invoice factoring agreement. This fee is usually 1% of the agreed facility – whether or not your company has taken full advantage of that facility.
Ad Hoc Charges
Ad Hoc charges may arise under a number of circumstances and it is vital that these are discussed before any agreement with a factor is reached. They may include processing fees or those raised if a client’s payment is late, if the funds paid do not clear or for other banking functions. Ad hoc fees, however, will vary from factor to factor, and it’s worth getting a full list in advance.
Termination charges arise when you decide to end your working relationship with a factor, and most have some kind of termination fee. The nature and size of these fees can vary a great deal. Sometimes they are punitive in order to encourage clients not to terminate their invoice factoring arrangement.
Termination fees may be a fixed lump sum, a percentage of the facility on offer, or equivalent to a projection of what the factoring company had expected to gain from the contract. Factoring companies usually require at least three months’ notice of termination. One way of negotiating around termination fees is to set up a month-by-month contract or to negotiate the details of any termination fees before contracts are signed.
Short-term agreements such as these are usually set up around single invoice factoring for a large sum. Should you decide to change factor halfway through a contract, the new factor may be able to negotiate this with you or simply pay the old factor for taking on your business.
For more information on factoring read our Buyer's Guide to Invoice Finance Companies.
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