When you deal with factoring companies so you can get the funding you need, you’ll need to sign a contract. But before you sign on the dotted line, you should make sure you understand all the business finance terms. That way, you can anticipate what’s going to happen. You’ll know how much capitalization you’ll receive, and how much you have to pay.
The problem is that sometimes you may not be fully aware of what the business finance terms in the contract mean. Before you enter into an agreement with factoring companies, make sure you take note of the following considerations:
- Advance rate. This is the money you get in advance, represented by a percentage of the value of the account receivable. Most of the time, The advance rate hovers around the 80% mark. Some of the more inherent industries may only have a 70% advance rate average. However, some specialist factoring companies in certain niches may promise an advance of up to 95%, although this rate depends on the credit history of your customers.
- Discount rate. This is the fee represented by a percentage of the value of the account receivable. The discount rate similar to the interest charged by a bank when they give you a loan. When your customer finally pays up, the factor takes the percentage from the payment before they pass on the payment to you.
Usually, this rate ranges from 1 to 6 percent, but you also have to pay some attention to the period of time it covers. For example, a 1% discount rate may only apply for 10 days, so an invoice which sets 30 days for payment may actually have a 3% discount rate, and payment within 60 days would then cost you 6%.
- Reserve amount. Usually, the factor holds back an amount of money from the payments to cover any instance of non-payment. The amount of money for the reserve differs with each factor, and obviously you want this to be as low as possible, so that you get more working capital.
- Length of time. This is the specified time during which you make use of the factoring process. You’re usually locked in for a specified period, and in that time frame you’re required to submit some accounts receivable for factoring.
The contract may also define which account receivable should be factored. You may be given a choice, or there may be a minimum number of invoices involved.
- Fixed fees. Many factors charge additional fees aside from the discount rate. For example, there may be a fee to set up a factoring line, while each particular account receivable may have a fixed factoring fee as well. There may also be a fee when you end the factoring agreement early.
- Late fees. There may come a time when a customer pays late. Every instance of this entails a penalty because the factor didn’t get back their money on time.
Take note of all these considerations and you can use them to compare which contract is better when you’re trying to choose among several factoring companies.