Many business owners today still insist on applying for a bank loan when they need financing, but an increasing number of small businesses are choosing accounts receivable factoring to provide the financing they need.
But how much will such services cost? Here are some of the expenses you need to expect when you do business with a factoring provider:
- Startup fees. When you setup a factoring line, you’ll probably be asked to pay a certain fee. This is to cover what the factor needs to do in order to open an account with your company.
- Transaction costs. There’s usually a small fee per invoice that doesn’t change regardless of how much the account receivable is worth. And this is why factoring a small number of large-value accounts receivable is preferable to factoring numerous invoices with smaller value.
Let’s say for example that the factoring cost per invoice is $2. So that means it will cost you $2 to factor one invoice worth $100,000 but it will cost you $200 to factor a hundred invoices worth $1,000 each.
- Factoring fee. This is the percentage of the amount involved in the account receivable. So if your accounts receivable total is $100,000 and the factoring percentage is 3%, the fee will cost you $3,000. For that, you may get 80% of the value of your accounts receivable in advance, and that means you get $80,000 in one day instead of waiting 30 days for your customer to pay in full.
- Reserve account. This isn’t really a fee, because this is a percentage of your money that is held in reserve by the factor in case one of your customers fails to pay. In factoring, you’re still liable for the advance money you receive when your customer is unwilling or unable to pay. The reserve account usually covers this risk. While factors differ as to what percentage to apply to your invoice for this reserve account, some may hold as much as 20% back into the account.
- Monthly fee. Many factoring agreements involve contracts specifying the period your accounts receivables will be factored by the financing company. Some of these financing companies charge a monthly fee.
- Termination fee. When you terminate the factoring agreement because you’ve shored up your cash flow difficulties, your factoring company may charge you a termination fee as well. This usually applies if you break your agreement with the factor earlier than expected or if you didn’t get as much funding as expected.
When you think about it, it does seem that accounts receivable factoring is more expensive than a bank loan. But that’s assuming you actually get a bank loan in first place. If you take into account what it will cost your business if you fail to get a loan on time, then factoring makes a lot more sense. You’re more likely to get the funding you need quickly, and that allows you to cover essential expenses and take advantage of growth opportunities.