How much does it cost for Invoice factoring? what are the costs associated with it? Factoring can prove to be an excellent funding solution for small businesses in need of a rapid injection of cash. As with any business decision it comes down to cost. As all quotations are for factoring are unique the costs are dependent on a number of different situations
Our insight may help explore these in detail throughout this article. Invoice Factoring is a flexible funding solution and a form of Asset Based Finance that allows you to sell your outstanding invoices to an Invoice Factoring provider, who gives you an immediate cash advance of 80% to 95% invoice value and takes over your customer collections.
Invoice Factoring Costs
What are they? In the UK, there are over 50 Invoice Factoring providers that are either independent companies, subsidiaries of financial institutions, or crowdsourcing platforms. Because of their different backgrounds, they also range in offerings, costs, and contracts
Invoice factoring rates come in a different forms and your understanding of them may not be clear. Factoring fees are never a flat rate, so percentages start at point five of a percent. Knowing the facts about invoice factoring costs will enable you to negotiate well, and get the best invoice factoring UK rates for your small business. Instead, costs vary depending on factors such as your invoice volume, industry, and business stability. In order for you to choose the right Invoice Factoring solution and provider, you need to understand and anticipate what costs are involved.
The elements of the make up of invoice factoring costs are:
- Set-Up Fee (Cost to set up the facilities and credit check your clients)
- discount charges (interest) offered
- service or management fees
- any additional costs – eg for additional services such as credit protection
- notice period for ending the service – most providers require three months’ notice, but some have notice periods of up to a year which could be expensive for your business
These are the main determiners of final invoice factoring costs. There may also be extra factoring costs incurred, but these are the primary ones.
Factoring Costs Example
The invoice factoring rate is also referred to as a factor rate. This is much like the concept of borrowing from a bank that you are likely familiar with. It is the cost the invoice factoring company charge you, usually on a weekly or monthly basis, for releasing the cash to you.
These factoring charges are worked out on a percentage basis of the invoice value, typically ranging between 0.5 – 5%. Generally speaking, the more you ‘hand over’ in terms of value (quantity and size of invoices), the lower the factor rate will be. Factoring fees are better if you factor higher value sales invoices. Please see the example of factoring costs below.
When taking into account the costs, Invoice Factoring providers consider the following variables:
- Volume of invoices per month and the amount
- Customer Creditworthiness
- Industry types
- Stability of the business
- Invoice Payment Terms
Should your business be classed as a low risk by one of the credit agencies and submit a high volume of invoices to be factored, in theory a lower rate will be offered.
Example of Invoice Factoring Costs based on a £600,000 turnover business :
Type of Facility Full Factoring
Initial Payments Percentage 75% of Approved Debts
Funding Review Limit £80,000
Set up Fee £365
Service Fee 1.3% of Invoice Value, subject to a monthly minimum fee of £550
Discount Fee 4% over the base rate on Funds in Use, subject to minimum base rate of 0.5%
Selective Credit Protection 0.7% of invoice total, if required
Concentration Percentage 100% of Invoice Value of all outstanding Approved Debts subject to bad debt protection limits.
Recourse Period 90 days from month end
Re-Factoring Fee 1% against invoices outstanding after 90 days from month end
Breakdown of Factoring and Invoice Discounting Costs
- Discount charge
The discount charge works in the same way as bank interest, just like you’d pay on a bank loan, overdraft or business credit card. It is the cost, calculated as a percentage of the invoice value, for releasing the cash to you. This charge will be applied usually on a weekly or monthly basis and will typically range from 0.5 – 5 percent. Generally speaking, the higher the value of the invoice you want to release funds from, the lower the discount charge will be. For that reason, it often represents better value to release funds from higher value invoices.
- Service Fee
The provider will also charge a service fee to cover the administration costs associated with delivering the facility. The credit management fees for invoice discounting are typically lower than factoring because you retain the responsibility for collecting and managing your own debts, so there’s less work for the invoice finance provider to do.
The credit management fee for invoice discounting could range from 0.2 – 0.5 percent of gross turnover, while typical fees for a factoring agreement are likely to be between 0.75 and 2.5 percent of turnover.
- Credit protection charges
These will be levied in non-recourse factoring arrangements, where the factor is liable for any bad debts. The amount will largely depend on the factor’s assessment of the level of risk. Typical charges range from 0.5 per cent of turnover to 2 per cent of turnover.
- Notice period to end the service
This is the amount of notice an invoice finance provider requires in order to bring the arrangement to an end. This is typically a period of around three months but it can be as long as a year. During this time all of the charges will have to be paid.
In a nutshell, the length of the factoring period is the amount of time it takes your customer to pay their invoice. Factoring fees reflect risk and patience for the factoring company. As the discount rates are paid as percentages, usually weekly or monthly, the longer the time your customer takes to pay, the higher the factoring charges. Therefore, if your invoices have a 30 day payment period you will pay considerably less than if they have a 90 day payment period.
Invoice Factoring Terms
Let’s consider a £20,000 invoice which is due for payment in 30 days. As a small business, you need some urgent cash to be able to buy the resources you need to take on a new client. So you turn to invoice factoring. The company you choose has a discount rate of 3% per month. Their terms state that you will get 80% of the invoice cost immediately (usually within a day or two), and full payment on the invoice when your client pays.
This means that you will immediately receive £16,000. You do not have to wait for the customer to pay the outstanding invoice. Assuming your customer pays the outstanding invoice in time, by 30 days, you will then receive £3400. This is the outstanding amount minus the 3% rate which is equivalent to £600.
In this example, the cost of factoring is £600.
What Can Affect The Cost of Factoring?
Lenders will have their set parameters of how they usually work out a factoring rate. This will look at two key factors that can effect the cost: the risk, and the volume of invoices. Generally speaking, the lower the risk and the greater the volume, the lower the factoring charges. Conversely, the higher the risk, and the lower the volume, the higher the invoice factoring costs.
Understanding this in more detail requires an understanding of exactly what an invoice factoring company will be looking for to calculate factoring fees. The invoice factoring company is going to assess your risk and volume using certain criteria.
Invoice Factors will consider:
- How much you will be factoring: The greater the volume, the lower the rates. This is probably the biggest determiner of your invoice factoring rates.
- The size of each invoice: No matter what the size of an invoice, the legwork for collection is exactly the same. Therefore it pays to have fewer larger invoices rather than lots of smaller ones. The invoice factoring company may seek to pass the costs of collection onto you, so consider which invoices you factor wisely.
- Your business niche and industry: The invoice factoring company will assess your business niche and the track record of your industry when determining your invoice factoring rates. Certain industries, such as recruitment, tend to be considered low risk as payment is normally simple and straightforward. On the other hand, the building trade can find themselves facing higher rates as they are deemed higher risk.
- The reliability of your clients: Reliable clients, who have a track record of paying on time, make for lower invoice factoring fees than those with a poor credit history. This does not always directly affect fees, but you may need to be more aware of overdue fees, or that the invoice factoring company may not accept invoices from certain clients at all.
- Your business reliability, longevity and turnover: Many factoring companies in the UK will want you to have been trading for at least a year. This can pose a problem for some start-ups. They may also expect you to have a minimum turnover, perhaps in the region of £25,000. In the UK, some invoice factoring companies want you to be a limited company. Being able to prove reliability will help you negotiate lower rates.
Weighing Up the Costs
When it comes to deciding if the costs for factoring are worth it for your venture, businesses will need to get a rough idea of how much the financing of each invoice is going to be worth to them. In a great many cases, the cost of the facility is negligible compared to the potential costs of having poor cash flow, which is why invoice finance is used by over 48,000 UK businesses. Good cash flow can increase profits, and prevent the use of more expensive types of credit. It’s essential however to sit down and understand exactly how much the costs will be and whether they’re right for your business. This may mean that it’s worth consulting outside advisers, like Invoice Funding.
The information on this page should help you to understand invoice factoring costs better, and it should also help you to understand exactly what you will be paying for. To find the exact prices that you will be paying, you should speak to as many suppliers as possible – we can help here.
Is Invoice Finance for my Business?
If you feel Invoice Funding may work for your business, and would like some invoice factoring costs from companies. Invoice Funding is one of the UK’s leading invoice factoring broker and gains preferential rates from funders. To get a quotation simply complete the online enquiry form. Once it is received a funding specialist will contact you by return.