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March 22, 2023

Invoice Factoring: A better alternative than a bank loan

Invoice Factoring: is it cost-effective?

A common myth surrounding the factoring industry is the cost.AdobeStock_233119995-1

Many believe, for example, that invoice factoring is too expensive to be a viable form of commercial financing. The problem with this line of thinking is that it puts the emphasis on the cost instead of asking the simple question, "Will factoring achieve the goal?"

Factoring, in essence, involves discounting accounts receivable in order to get paid sooner rather than later. Discount fees can range from as low as 1% up to 3% depending upon a variety of factors including;

  • The total number of invoices to be factored
  • The average amount of total invoices
  • The customer's stability and creditworthiness
  • The average payment terms or total days before an invoice is due
  • The total number and type of customer mix

Invoices due in 30 days on average, for example, may be discounted 1 to 2% versus 2 to 3% for invoices due in 60 days for normal commercial invoices.

While the term "discount" is often also referred to as "rate," it is not to be confused with rate in the context of a loan. This is a common mistake. Since factoring is not a loan, a factoring discount rate of 2% is not the same as a 2% APR on a loan. APR stands for annual percentage rate and a 2% APR suggests 24% interest per year.

A factoring invoice fee of 2% applies to a one-time fee associated with an invoice amount, versus a discount fee that is applied to the invoice amount over a series of months into the future. Also, when you factor an invoice, you are not borrowing money as is the case with a loan and the corresponding APR. Put differently, the invoice factoring discount (fee) of 2% can be viewed similarly to offering a customer a 2% quick-pay discount when they pay in 10 days rather than at 30 days.

The bottom line, it pays to understand the numbers when it comes to succeeding in business.

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