In recent years there have been many factoring companies out there offering what seems like impossibly low factoring rates. Often times these rates can be less than even one percent. To any business that has used factoring, these rates sound amazing, and certainly that is the hope of the factoring companies offering these rates. However, like most things in life, if it's too good to be true, it usually is.
The reason why these factoring companies can offer such low rates is because they charge their clients interest for as long as the money is out. At the end of the day, these impossibly low rates typically wind up costing you more than a traditional flat rate factoring fee would. Over the last few years at DSA Factors we’ve had several companies ask us for low adjustable rate factoring, but when we show them the math, all of them have decided to stick with traditional flat rate factoring.
What is fixed rate factoring?
With fixed rate factoring you are told how much it will cost to factor an invoice up front. While the rate can change based on how long the terms of the invoice are, you will not be charged any interest, even if one of your customers pays late. You know exactly what the factoring fee is every time you submit an invoice to your factoring company.
There are three major advantages to fixed rate factoring.
- You know exactly how much it will cost to you to factor an invoice, thus making it much easier for you to build the cost of factoring into your prices, not to mention your accountant will probably appreciate it as well.
- You know that your factoring company will do its best to collect your invoices in a timely fashion and won’t let a missed invoice stay on your aging for too long.
- Your factoring company will do its best to collect all invoices in a timely fashion, meaning less past due accounts that cannot be approved for reorders.
The disadvantage to fixed rate factoring is that you still pay the same fee even when a customer pays an invoice early. However, at DSA Factors, if you have customers who consistently pays for invoices early, we would be able to work with you on these accounts and put together an early pay refund for when these customers pay early.
What is adjustable rate factoring?
With adjustable rate factoring you have a very small fee required to factor the invoice, but as soon as you get funded for the invoice the clock starts ticking and the interest starts accumulating. Most of these factoring companies count days within blocks, which are typically 10, 15, or 30 day blocks. You then get charged a fixed percent based on how many blocks you use. For example, if it takes 42 days for a factoring company to get paid for invoice, and they wait another 10 days for the payment to clear the bank as most factoring companies do, you would get charged for either six 10 day blocks, four 15 day blocks, or two 30 day blocks. So say the base rate was .5% and it costs 1% for each 15 day block, the actual rate of factoring this particular invoice is 4.5%.
Adjustable rate factoring can be cheaper if your customers always pay their invoices early, or if you wait several weeks to submit your invoices to your factoring company. However, since one of the primary reasons to factor your invoices is to speed up your cash flow, it probably isn’t necessary to factor customers who pay early, and you probably can’t wait several weeks to submit your invoices for funding.
A major disadvantage to adjustable rate factoring is that your factoring company has little motivation to collect in a timely fashion. If you have a good customer and they happen to miss an invoice, which we all know happens from time to time, your factoring company might not bother to tell them until the invoice is 30 or even 60 days past due, after all, the longer the money is out, the more money that they make.
Which rate structure is best?
At DSA Factors we strongly believe that fixed rate factoring is not only more honest, but it is also the cheaper option.
The important thing to do is to make sure you understand exactly what you will be charged for before signing a contract with a factoring company.
No factoring company that offers adjustable rate factoring is going to advertise the interest charges to you, after all the main benefit of adjustable rate factoring is that your marketing team can offer impossibly low rates. It is important that when you get a contract from a factoring company that you read through it carefully to make sure that you will not be charged interest while your factoring company is awaiting payment on your invoices.
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