One of the surest ways of comparing factors is to get a factoring proposal from each of them. Here’s how you do it:
- First you need to make sure that the factoring proposal contains all the necessary information. It has to specify the advance, which is the percentage of the value of the invoice given to you initially; the discount, which is the rate you pay for the cash advance you receive; and the factor’s additional fees.
- Next, check if the advance is enough for your needs. Get a list of the invoices you will submit (and those which you know will be approved for factoring) and then calculate how much you can get in advance for them. Is the amount of money you’ll be receiving in advance sufficient? Keep in mind that some lenders may offer only 70% of the value of the accounts receivable, while others may offer as much as 90%.
If the advance from a particular lender is not enough for your needs, then they need to be eliminated among your candidates.
- Now it’s time to look at the discount rate. This is much like the interest rate for loans. There are several ways of looking at this number. For example, some experts recommend that you find out the “true cost per dollar” by dividing the discount rate by the advance rate. A 70% advance rate with a 3% discount rate gets a true cost per dollar of (0.03 ÷7) of $0.0429. But an 85% advance rate with a discount of 3.6% has a lower total cost per dollar at just $0.0424.
What you need to remember is that the discount rate applies to the amount of the invoice, and not to the money you get in advance. This is why getting a larger advance is better than a smaller one. If you get $80,000 in advance from your $100,000 invoice, you pay $3,000 for the privilege if the discount rate is 3%. But if the advance is just 70%, then you only get $70,000 and you still pay $3,000 for that money.
- Finally, you need to think about all the ancillary fees the factor may charge. There may be setup fee for the factoring line. There may also be a fee for each account receivable, so that a pack of ten receivables totaling $100,000 can be ten times more expensive in ancillary fees than a single receivable worth $100,000.
- Add the total cost into your analysis, so that you will have a very clear picture of how much you will get in advance and how much you have to pay for this kind of service. The lower the total cost, the better it is for you.
Just keep in mind, however, that when you get a factoring proposal it should not be your only consideration. You need to know if the factor is easy to work with, if they are trustworthy and professional, and so on. You will need to ask for references to find out.