Authored by Phil Cohen
One of the most difficult challenges businesses are running up against in 2024 is the difficulty in accessing capital. Lenders have tightened their requirements, interest rates are still elevated, and narrowing profit margins makes debt less attractive. Yet cash flow is still one of the most important factors in maintaining your everyday operations. Factoring is a popular solution, but is it the right choice for your business?
Examine the costs vs the benefits of factoring before diving in to this option. We’ll help you take a look at the pros and cons below.
How Factoring Works
First, a quick review of how factoring works. When you factor your invoices, you sell them to a factoring company, who then presents you with the majority of the invoice value up front (usually 80%-90%). You get the cash, and the factoring company chases the customer for the invoice payment when it’s due. Once the customer pays, you get the remaining 10% minus a factoring fee. Some factoring companies charge their fee upfront instead.
Now, let’s break down that factoring fee and other costs associated with using a factoring company to access capital.
Factoring Costs
Like any business, factoring companies charge for their services. These costs typically include a factoring fee and may include other fees as well depending on the company, the contract, your customers and the size of your invoices.
Factoring Fees
The factoring fee is what the company charges for the service. It’s typically between 1.5% to 2.5% of the invoice value; some companies charge a factoring fee followed by a monthly fee until customers pay (for example, 1.5% factoring fee and 0.5% monthly fee). This fee could vary if you have a larger volume of invoices to factor or if your customers are more of a credit risk.
Other factors that can affect the factoring fee are the discount rate, the factoring period, your industry, and whether you choose a recourse or non–recourse contract.
Other Fees
Depending on the factoring company, there may be other costs in addition to the factoring fee. These may include:
- Credit check fee
- Wire transfer fee
- Account management fee
- Processing fee
- ACH fee
- Penalty / late payment fee
Tip: Make sure your factoring company or the factoring broker you work with is transparent about all applicable fees.
Factoring Cost Example
Suppose you have a staffing company that’s short on capital to make payroll. You have $20,000 in invoices, but they aren’t due for 60 days. The factoring company buys the $20,000 in invoices and charges a fee. Here’s a simplified example of how that would work, depending on the type of factoring fee:
- Flat-rate factoring fee: If the fee is a flat 2.5%, you’d receive 97.5%, or $19,500. The factoring company keeps their $500 fee regardless of whether the customer pays in 30 days or 60 days.
- Tiered factoring fee: If the factoring company uses a tiered cost structure, you might pay 1.5% up front ($300) and then 0.5% ($100) every 30 days. If the customer takes 60 days to pay, that would be $100 + $100 + $300 upfront = $500.
Factoring Benefits
Do the benefits of factoring outweigh the costs? That question can be unique to every company. To help you decide, consider some of the advantages:
Improved Cash Flow
Clearly, a major benefit of factoring is the immediate cash flow. Instead of waiting months for your customers to pay, you can get access to the majority of the invoice value right away. That lets you cover payroll, pay vendors, make rent, buy fuel – whatever your company needs before invoices are due.
No Additional Debt
Unlike traditional loans, factoring isn’t a form of debt. Rather, you’re selling an asset (your invoices). Factoring doesn’t add to your liabilities, and you don’t have to pay financing charges.
Flexible Funding
You can factor your invoices when you need to and skip it when you don’t. Factoring is a flexible method of accessing capital, and it can grow with your business as it scales.
How to Know If Factoring Is Worth It
If you want to know whether factoring makes sense for your business, start with the math. A factoring broker can help you compare the rates and terms from several different factoring companies. You can also compare those offers to the terms you’d get with a traditional bank loan or similar funding source.
But you also need to consider the opportunity cost of not factoring. If you skip the loans and decline to factor your accounts receivable, what opportunities might you miss out on? You might not be able to purchase a piece of equipment you need when it’s discounted, for example. Another point to consider is what strain your business can withstand when there are significant funding gaps. Can your staff tolerate late payments? Can your clients wait around until you have the cash to fill orders?
If your business is facing a cash flow crisis, factoring can be a cost-effective solution that keeps the operation running smoothly.
The Bottom Line
If you’re considering factoring as a solution for your business’s cash flow needs, it’s important to weigh the costs against the benefits. While there is a fee for factoring, the ability to access immediate capital, improve your cash flow, and avoid debt can far outweigh the expense—especially in today’s fast-moving business environment.
You should weigh the costs and benefits of factoring as you would with any other business decision. While there is a fee for factoring, consider the value of what provides: access to capital, improved cash flow and avoiding debt. If factoring sounds like the right solution for your company, contact us to connect with the right factoring company for your needs.