Factoring fees are fundamentally different from interest rates. Factoring amounts to a discounted purchase of an invoice (or a package of invoices). This means that the fee the factor takes will be based on the face value of the invoices for which the factor provided funding.

For example, if a Factor offers a 3% rate, then a $1,000 invoice will be funded for a $30 fee. This $30 fee is paid when the invoice is paid by the debtor.

However the fee can change based on how long the invoice has been outstanding. Usually a factor’s fees will increase at set mile stones. When the aging report shows an invoice past 45 days, 60 days, 75 days etc. the factor will add a predetermined percentage, usually below 1%, on to the 3% base rate.

This fee structure means that the factor will not know what fee will be charged on any given invoice until it is paid. This is why factors only advance a percentage of the invoice, usually between 70-90%, and hold the remaining percentage as ‘reserve.’ This reserve will paid back to the client, minus factoring fees, once the invoice is paid by the debtor.

This is in contrast to traditional interest chargers that accrue daily, and might be simple interest or compounding interest. As well, loans might be interest only or amortizing. Click here for more differences between factoring and traditional loans.

Factoring Fees: Different from Interest Rates is a post from: Factor Direct Capital

Direct lender

First and foremost, make sure you are working with a direct lender. There are many websites that appear to be legitimate factoring companies but they are actually just brokers that will pass off your information for a commission. This is not the worst thing that could happen, but dealing directly with a lender ensures that you can decide what company is the best fit for you. (rather than which company will give the broker a larger commission)

Familiarity with your industry

Some factors specialize in one industry, whereas others deal with all types of businesses. Going with an industry specific factor will ensure that they are knowledgeable in your field. Even if a factor does not specialize, ask if they have worked with businesses like yours in the past. This will ensure that the factor is a good fit for your business and vice versa.

Account management

It is best to have a dedicated account manager. This will make dealings less confusing and more personal as there will be only one person to contact for all of your factoring questions, needs, concerns or issues. As well, you will build a relationship with that person, which means they will be more likely to cater to your needs and will work harder to keep you happy with their service.

Time it takes to disburse the funds

Considering how fast they can respond to requests for funds is important because factoring is about timely cash. If a factoring company cannot get you funds on the same day or within 24 hours, it should not be hard to find one that does. A 2-3 day wait time could be the difference between making payroll on time or not.

Customer relationship management

You have worked hard to build relationships with your customers; you do not want a factor to disrupt this. Ask the factor about their collections policies and how aggressive they are with collections. Some factors will allow their client to handle collections or offer non-notification factoring if this is a concern.

Fees

Every factoring arrangement has factoring fees; they are calculated as percentage of the face value of an invoice. However some factoring companies will charge other ‘setup fees’ or ‘service charges.’ It is probably in your best interest to avoid these factors, or at least to fully understand their fee structure before you commit to them.

Volume requirements

Virtually all factors have a certain monthly volume range that tends to be a guideline for clients they will work with. Some factors will deal with clients that have receivables volumes of $100,000-10 million monthly, and other factors might deal in the $5,000- 100,000 range. Point being it is important to know which factor is suited for your business volume.

In addition, some factors will require their clients to factor a monthly minimum amount of receivables whereas some have no monthly minimums. Choosing a factor with no monthly minimums is the most flexible arrangement as you are not obligated to factor in the event it is not needed.

Contract length

Lastly, some factors require that you have at least a year contract with them. Others offer month-to-month contracts. You should consider how long factoring will be needed for business operations before you commit to contract. If you will need it for well over a year then this should not be an issue, but it is smart to not over commit. Contracts can always be extended, but getting stuck factoring when it is not longer advantageous should be avoided.

What to look for in a factor? is a post from: Factor Direct Capital

The only similarity between the two services is that they function to help businesses receive payment on accounts receivables. However they achieve this end through completely different methods.

Factoring works as a cash advance on an accounts receivable. It allows the business to have immediate access to the money that would have otherwise been inaccessible. This means that factoring is a form of financing, leveraging accounts receivables like a revolving line of credit. In a factoring arrangement usually 80% of the value of the receivable will be advanced immediately upon invoicing the customer. Once the factor receives payment on the invoice the remaining 20% is given back to the client minus the factoring fee.

A collections agency, on the other hand, comes into play once the account is delinquent and serves to hasten payment as well as avoid default. If the business has an ‘in-house’ or ‘first party’ collections agency then it will be more geared towards speeding up payment and will get involved earlier in the process compared to a third party collections agency. A ‘third party’ or ‘outside’ collections agency usually deals only with accounts that seem to be a default risk. Third party collections arrangements can work a number of ways. Some agencies make money based on a percentage of the revenue they collect, typically ranging from 25-40% of the value of the receivable. Other agencies work on a flat fee basis, and others will purchase the uncollected debt, usually at a substantial discount, and assume the debt as their own.

It is clear that factoring and collections are two different tools with completely different costs to the business, and affects on cash-flow. Factoring will improve any business’s cash flow, whereas collections can only provide value for businesses that have issues with payment. Even if a business has payment issues, factoring will improve cash flow much more than collections simply because it allows the business to get paid upfront. The cost of factoring compared to collections is completely based on the situational variables; whether the collections where done in-house or through a third-party, what percentage of invoices were being factored, the volume of sales etc. Generally speaking factoring is more expensive then a third party collections agency, and could be significantly less then in-house collections based on the size of the company.

However it is important to note that factoring inherently provides collections services. Factors will keep close watch over the status of an invoice, and if there is an issue or concern with the payment the factor will follow up with the company, and resolve the issue on behalf of their client. This is at no extra cost to the client.

One issue with both factoring and collections agencies is the concern that they will not manage your customer relationship right, and as a result you will lose the customer. This can be a legitimate concern and because of that, there is factoring on a “non notification” basis. What this means is the customer will not know that the invoice was factored and the factor will not contact the customer. Obviously this would negate the aforementioned inherent collection service in a factoring arrangement, as collections cannot be done on a non-notification basis.

It is important for business owners to understand the difference between services so that they can select the service that will best remedy their problem. A collections agency should be used when a business is trying to minimize default. Factoring should not be used for this reason. Factors should be used as a financing tool on quality invoices. Factoring will not provide much value to a business if the factor is assuming invoices that are going to default. Even if factoring is done on a “non-recourse” basis, the factor will usually recoup their money by taking it out of future payments. Therefore selling bad invoices to a factor will only delay the cash flow hit that occurs with non payment. However a collections company can help lessen or eliminate the non payment and would provide more value if default appears to be a significant risk.

Factoring or Collections Agency? is a post from: Factor Direct Capital