When you are trying to improve your company’s cash flow, you will naturally focus on the cost of the financing option you choose – after all, why pay more than you have to for the cash you need? For that reason, factoring fees may seem like a greater gamble than the lower interest rates a bank or credit union can offer in a traditional lending agreement.
However, when you consider the cost of factoring you have to look at every angle of the relationship and fully evaluate how that cost will affect your business – and your bottom line – in relation to similar costs incurred by a small business loan.
Below, we will address common concerns about factoring rates so you can make the most educated decision for your company before pursuing funding.
Bank loans are cheaper.
As we mentioned above, the interest rate a bank may charge you for a small business loan is likely to be lower than the rate an invoice factoring company will quote you for their services. However, financing your business is like many other investments in life in that you get what you pay for. There are substantial benefits to beginning an invoice factoring relationship rather than taking out a loan:
- Factoring does not create debt. Unlike a loan, you are merely converting your own assets into cash you can use today. You can actually build your credit by using factored funds to take advantage of early payment discounts and closing out old debt, leading to a cleaner balance sheet.
- There is no limit to how much you can factor. A bank loan comes with a set credit line, and extending that line usually requires even more stringent qualification than the initial loan approval process. With factoring, however, your funding potential grows with your sales so the line is constantly moving to fit your company’s needs.
- A factoring company will do more than just send you cash. Your factoring relationship will also include administrative support with background checks or credit verifications and collections efforts, at no additional cost to you! The money you will save by not using these expensive services on your own will more than offset your factoring rates.
Most importantly, invoice factoring is an option for companies that can’t qualify for a small business loan. If you have poor credit or collections histories, are just starting your company, or fail to provide the necessary collateral, even the most flexible bank or credit union is likely to turn you down. However, factoring companies are prepared to offer reasonable terms to companies in any combination of these situations.
Factoring is too expensive!
Whether factoring is too expensive in general depends on how you approach the cost. If you convert the cost of a single transaction into a yearly expense on your books then you will quickly see a rising balance…one that is completely inaccurate.
If you factor a $1000 invoice that stays open for 50 days and your factor charges two percent every ten days, the fee for that invoice is only $100 – you will receive $900 of the invoice value! Like a hotel room, car rental, or other temporary expense, the factoring fee for your invoices is only applicable for the time that the invoice is open. Don’t think of your factoring rate as a continuing expense; rather, it is a short-term cost for a long-term financial solution.
If you still aren’t sure, consider what it would cost you to not factor your invoices. In the previous section we explained how factoring companies offer cash flow security to companies that cannot qualify for a traditional bank loan. Companies in that situation risk losing significant earning potential by not factoring.
For example, let’s go back to our $1,000 invoice from a few paragraphs ago. Let’s say you would earn $600 profit on that invoice after covering payroll and other expenses. If you factor that invoice, you would pay $100 in fees and net a $500 profit. You may decide that you would rather keep that $100 in your pocket, so you won’t factor the invoice.
I can earn $600, or I can factor and only earn $500.
But can you afford to do the work without factoring?
Companies facing cash flow difficulties often have to turn down work because they lack the working capital to pay associated up-front costs. In reality:
You can factor and earn $500 profit, or you can not factor and earn $0.
My customers don’t pay, so I end up paying higher fees.
Work with better customers.
We may sound glib, but this is critical to your company’s success with or without factoring – and beginning a factoring relationship gives you the opportunity to evaluate what your customers really bring to your business.
A customer that consistently pays late or skips payments is not a good customer, especially if they are a significant source of your revenue. By working with established and creditworthy customers, you can minimize the length of time invoices stay open and, therefore, the fees you pay on them. The best thing you can do for your company is build a wide network of reliable customers and gradually scale down your work with your “bad” customers.
Your factor will evaluate your current customers before approving their accounts for funding. Approved customers will have a credit limit that reflects their creditworthiness. As you build your customer base, the factor will evaluate new potential customers before you begin work so you go into the relationship with all of the information you need.
The cost of factoring is more nuanced than a dollar amount on the page, and by doing careful research you can reap all of the benefits that an invoice factoring relationship has to offer. Contact Factor Finders today to learn more about invoice factoring and to receive a proposal with competitive factoring rates that reflect your company’s needs!