Invoice factoring costs can vary and are dependent on the performance of your business and the reliability of your clients. While there is no standard pricing, understanding the key factors can help you estimate the overall cost.
Typically, the total cost of factoring is determined by two main elements: the discount/factor rate and the length of the factoring period.
The discount or factor rate, ranging from 1.5% to 5%, is influenced by the value of the invoices you submit for factoring. Generally, higher invoice values result in lower discount rates.
The length of the factoring period depends on your clients’ payment terms and their actual payment timelines. If your clients take longer to pay, extending the factoring period, it will result in higher costs.
It’s important to note that additional charges such as service fees and collection fees might apply, further impacting the overall cost.
If this seems overwhelming, don’t worry! We’re here to assist you. By answering a few quick questions about your business, we can provide you with customised quotes from leading invoice factoring companies in the UK.
Invoice factoring fees and costs
Invoice factoring fees can vary depending on the fee structure offered by the factoring company. Most companies use a variable fee structure, where the main factors that determine the fees are the invoice discounting rate and the length of the factoring period.
The discounting rate typically falls between 1.5% and 5% of the total invoice amount. This rate is influenced by various factors, including the creditworthiness of your customers and the volume of invoices being factored. Generally, higher invoice values and more creditworthy customers can lead to lower discount rates.
The length of the factoring period refers to the time it takes for your customers to pay their invoices. This period can affect the overall cost of factoring. If your customers take longer to pay, it may result in higher fees, as the factoring company has to wait longer for payment.
- The discount rate / factor rate
- Length of factoring period
Discount Rate – Factor Rate
The factor rate, also commonly referred to as the discount rate, is an important aspect of invoice factoring that bears similarity to borrowing from a bank. This rate represents the fee charged by the factoring company for providing you with immediate cash, often on a weekly or monthly basis.
The discount or factor rate is calculated as a percentage of the invoice value, typically falling within the range of 1.5% to 5%. In general, the more value you transfer to the factoring company in terms of the quantity and size of invoices, the lower the factor rate will be. Opting to factor higher value invoices can result in more favorable returns on your factoring fees
- Low-end factor rate – 1.5%
- High-end factor rate – 5%
(This rate is annual and typically higher than either the Bank of England base rate or LIBOR.)
Length of factoring period
To put it simply, the factoring period refers to the duration it takes for your customer to settle their invoice payment. The fees associated with factoring are influenced by the level of risk and the degree of patience required by the factoring company.
Since discount rates are typically calculated as percentages paid on a weekly or monthly basis, the factoring charges increase as the time it takes for your customer to make payment lengthens. Consequently, if your invoices have a 30-day payment period, you will incur significantly lower costs compared to invoices with a 90-day payment period.
Invoice factoring cost example
Let’s take a look at an example to understand the cost of factoring a £20,000 invoice with a 30-day payment term. Imagine you’re a small business in need of immediate cash to purchase resources for a new client, so you decide to utilize invoice factoring.
The factoring company in question has a service fee of 1% and a discount rate of 3%. According to their terms, you will receive 80% of the invoice value upfront, usually within a day or two, and the remaining 20% when your client pays.
In this case, you will immediately receive £16,000 (80% of £20,000).
The service fee is calculated based on the gross value of the invoice, so 1% of £20,000 amounts to £200.
The discount rate is an annual fee, so to determine the daily interest rate, we divide 3% by 365 (days in a year), resulting in 0.008% (daily interest rate).
Multiplying the daily interest rate (0.008%) by the number of days it takes for your client to pay (30 days), we get 0.24%.
The discount fee is only charged on the advanced funds, which in this example is £16,000. So, £16,000 multiplied by 0.24% equals £38.40.
Therefore, the total cost of factoring your £20,000 invoice over a 30-day period amounts to £238.40.
What can affect the cost of factoring?
Factoring companies employ specific parameters to determine their factoring rates. These rates are influenced by two primary factors: risk and invoice volume.
In general, lower risk and higher invoice volume result in lower factoring charges. Conversely, higher risk and lower invoice volume lead to higher invoice factoring costs.
To comprehend this in greater depth, it’s crucial to understand the criteria that an invoice factoring company considers when calculating factoring fees. These companies evaluate your risk and volume based on specific criteria.
Invoice factors will consider:
- The amount you plan to factor: The volume of invoices you intend to factor plays a significant role in determining your invoice factoring rates. Generally, higher volume leads to lower rates, making it a key factor to consider.
- The size of each invoice: While the size of an invoice does not impact the collection process, it can affect the costs associated with factoring. It is beneficial to have fewer larger invoices rather than numerous smaller ones, as the factoring company may pass collection costs onto you. Carefully consider which invoices you choose to factor to optimize cost-efficiency.
- Your business niche and industry: The factoring company will evaluate your business niche and industry track record to assess risk. Industries with straightforward payment practices, like recruitment, are often deemed low risk and may have lower factoring rates. Conversely, industries such as the building trade may face higher rates due to perceived higher risk.
- The reliability of your clients: The payment history and creditworthiness of your clients significantly impact invoice factoring fees. Reliable clients with a track record of timely payments generally result in lower factoring fees. However, be aware of potential overdue fees and the factoring company’s acceptance policies for invoices from specific clients.
- Your business’s reliability, longevity, and turnover: Many UK factoring companies prefer businesses with a trading history of at least one year. Start-ups may face challenges in meeting this requirement. Additionally, some factoring companies may expect a minimum turnover, typically around £25,000. Being able to demonstrate reliability and stability can help you negotiate lower factoring rates.
Invoice factoring costs vs benefits
When considering invoice factoring, it’s important to take into account the associated costs. While factoring may result in receiving less money compared to direct customer payments, the benefits often outweigh the costs.
Invoice factoring allows businesses to generate cash and improve cash flow, which can be highly advantageous for small businesses struggling with financial management. It enables growth opportunities, the pursuit of new ventures, and essential repairs to maintain smooth business operations. Without a reliable cash flow, businesses may face significant challenges.
There are also hidden cost benefits to invoice factoring. Invoice administration requires time and resources that many small businesses and startups may lack. By entrusting invoice administration to the factoring company, small businesses can save time and allocate labor to more valuable endeavors such as acquiring new business deals.
Startups and small businesses often encounter cash flow issues. While they may consider traditional financing options like bank loans, these alternatives lack the flexibility offered by invoice factoring. Additionally, invoice factoring can potentially provide businesses with more cash at a lower cost compared to bank loans.
Overall, well-managed invoice factoring offers businesses a flexible and cost-effective solution. It not only enhances cash flow but also frees up valuable time that can be utilized to propel businesses towards new heights.
Other factoring charges
In addition to the fundamental factoring costs, it’s crucial to be mindful of other potential fees associated with invoice factoring.
Being aware of any hidden costs is essential in gaining a comprehensive understanding of invoice factoring rates. There are various factoring charges that you should familiarize yourself with and be vigilant about. Understanding the possibility of these fees being imposed empowers you to inquire about them upfront.
Some other factoring fees to consider are:
- Origination fees
- Incremental fees
- Service fees
- Collection fees
- Overdue fees
- Unused line fees
- Renewal fees
- ACH transaction fees
- Wire fees
- Credit check fees
- Termination fees
Origination fees, also referred to as draw fees, are fixed rates applied to each individual invoice. Typically, factoring companies provide an advance of around 80% of the invoice amount. However, when an origination fee of 1% is imposed, the actual advance you receive effectively becomes 79%.
In certain cases, invoice factoring companies adopt a flat-fee structure rather than a percentage-based discount rate. This can be appealing, particularly if you have concerns about customer payment reliability. However, be aware that you might incur an incremental fee as the unpaid invoice ages. Incremental fees are calculated as a percentage on top of the flat factor rate and can result in higher costs the longer it takes for a customer to pay. The percentage for incremental fees typically caps at 1%, but it’s important to do the math to evaluate the impact.
The service fee encompasses the cost of providing the facility, managing the account, and covering administrative expenses related to client accounts. This fee primarily covers the administrative processing of invoices.
One of the advantages of invoice factoring for small businesses is the delegation of tasks related to tracking, chasing, and collecting invoices. However, some invoice factoring companies may attempt to charge administrative costs associated with collecting unpaid invoices.
To mitigate the risk associated with customer non-payment, certain factoring companies may impose a flat fee for overdue invoices. It is crucial to review the terms and conditions regarding what happens when an invoice becomes overdue.
Unused line fees
During initial negotiations with a factoring company, you will determine the estimated amount of monthly factoring required. Some factoring companies have minimum thresholds. If you do not utilize the full estimated amount, you might be subject to an unused line fee as a penalty. These fees are calculated as a percentage of the shortfall in using their services. Although these rates are generally low, around 0.15%, they should be considered as part of the overall factoring charges.
Similar to origination fees, some factoring companies may levy an annual cost for renewing your account. These fees typically apply 12 months after initiating the relationship and can be a flat rate or a percentage of the factoring facility’s size. However, there are numerous companies in the UK that do not charge this fee.
ACH transaction fee
When payment on an invoice is advanced to you, a flat rate transaction fee may be applied for the transfer of funds. This fee is typically minimal, usually under £25, but it’s important to be aware of its existence.
If you opt to receive your funds through a method other than ACH (the preferred method), the factoring company may incur charges from their bank. These costs are usually passed on to you in the form of a flat rate, typically up to £40.
Credit check fees
Invoice factoring companies may need to conduct credit checks on both you and your customers with outstanding invoices. These credit checks incur fees that the factoring company may choose to pass on to you.
Certain invoice factoring companies may require you to sign a contract for a specific duration. If you terminate the contract before the end date, a termination fee may be imposed, usually calculated as a percentage of the factoring facility’s size
Invoice factoring costs: Compare prices and quotes
To provide a summary, here are the key factors that contribute to invoice factoring costs:
- Discount rate / factor rate: Typically falls between 1.5% and 5% of the invoice total.
- Length of factoring period: Refers to the time it takes for the customer to pay and clear the invoice. Longer payment periods usually result in higher factoring charges.
- Number of invoices: Generally, the more invoices your business wants to factor, the more favorable the rates.
- Invoice totals: Factoring fewer invoices with larger sums tends to be more cost-effective than factoring numerous smaller invoices.
- Industry risk: Different industries carry varying levels of risk. For example, factoring rates for low-risk industries like recruitment are typically lower.
- Business longevity and turnover: The factoring company considers these factors as indicators of risk.
- Additional fees: It’s important to be aware of various fees such as origination fees, incremental fees, and service fees, which may apply to your business. Confirm with your chosen provider which fees are relevant.
By understanding these factors, you can gain a better understanding of invoice factoring and what you’ll be paying for. To obtain specific pricing information, it is recommended to speak with multiple suppliers.
To assist you, you can complete the online form to receive quotes from reputable UK invoice factoring companies.
Lee Jones is a seasoned expert in the field of business finance with over two decades of experience. With a keen understanding of financial markets and a passion for helping businesses thrive, Lee has become a trusted advisor to countless companies across the United Kingdom.