If you need to accelerate cash receipts from accounts receivable to pay suppliers or keep your company operating, one alternative to consider may be invoice factoring. When you use invoice factoring, you sell your invoice to a factoring company for less than face value or a discounted amount, and may take cash advances which can be as little as 50-80% of the invoice amount. The factoring company holds the balance until the invoice is paid. The balance less factoring fees, disputed amounts and returns is then paid to you.
The mechanics of invoice factoring are pretty straight forward, but you need to be careful when you compare the cost of invoice factoring with other financing alternatives. The true cost of invoice factoring is much higher than it appears on the surface. Here are some things you need to understand to fully appreciate what invoice factoring really costs.
Factoring companies base their fees on a number of considerations including:
- Volume – Factor fees are very volume sensitive. Higher volume means lower fees.
- Invoice amounts – It takes the same effort to collect a $100 invoice as it does for a $1,000 invoice. Higher invoice amounts means lower fees.
- Credit quality of customers – Customers with poor credit quality require more collection effort. Better credit quality means lower fees.
- Recourse or non-recourse – With recourse you are responsible for the unpaid balance, so the cost to factor is lower than non-recourse.
- Your company’s credit quality – If you take advances on invoices factored, which most companies do, your company’s credit quality can influence factor fees. Higher credit quality means lower fees.
Factor fees can be over 5% of the invoice face amount for the first 30 days the invoice is outstanding, plus additional fees if the invoice takes more time to be collected. So on the face of it, your cost to factor an invoice in this example is the same as an effective annual interest rate of 60% (5% x 12 months). The true cost of invoice factoring is even higher.
TRUE COST OF INVOICE FACTORING
To calculate the true cost of invoice factoring you need to take into consideration the amount of the advance that you receive on the invoice factored. If you receive a 60% advance on an invoice and are charged a 5% factor fee for the first 30 days the invoice is outstanding, the true cost of invoice factoring is the same as an effective annual interest rate of 100% ((5% x 12 months)/.60). This is because the factor fee is based on the invoice face amount, not the amount you are advanced. The true cost of invoice factoring makes it a very expensive way to accelerate cash flow from accounts receivable.
Automation has made it much less costly to establish and operate your own accounts receivable and collection department, especially with the availability of cloud-based software subscriptions. Compare the costs of invoice factoring with collecting your own receivables and using them as collateral for a secured loan. You will be surprised at how much you can save if you automate and collect your own receivables.
Lockstep Collect is a leader in cloud-based and premise-based software solutions made especially for businesses selling on credit.
If you would like to learn more about how you can benefit from automating your accounts receivable and collections, please contact Lockstep Collect at www.lockstep.io.[/vc_column_text] scl-shortcode-cleaner-clean-content-end--> scl-shortcode-cleaner-clean-content-end-->