There is no one standard for factoring costs in the UK. The costs will vary depending on the size, nature and success of a company. Moreover, how the costs are named and broken down vary depending on which factoring company is chosen. The biggest single determinate for factoring fees is the reliability of the debtors. If your customers always pay on time then your company represents an ideal situation for an invoice financier managing a factoring facility and as such you should be offered more favourable terms.
There are two main considerations when looking at the costs of factoring. They are the discount rate and the length of the factoring period. The discount rate is given as a percentage of the prepayment made on an unpaid invoice. The discount charge ranges between 1.5% and 5%. The rate will reflect the cost of borrowing at the time as well as the risk the factoring company thinks it will take in buying invoices from the company in question. That risk will be assessed by looking at the quality of the debtors, the concentration of debt (is it spread evenly or is it dominated by only a handful of debtors?), the length of time a company has been in business, and an assessment of the future profitability of a company and its products.
The other consideration is the length of the factoring period. Thus, it is cheaper to get a prepayment on an invoice that is due for payment in 30 days than it is for an invoice that is due to be paid in 60 days. Many factoring companies will charge an extra refactoring fee for every day an invoice payment is overdue. Generally speaking, the longer an invoice remains overdue for payment the greater the chance becomes of a default and non-payment. An invoice financier who takes over the sales ledger of a company is paid to identify invoices where there is a strong likelihood of problems with payment and avoid offering factoring payments for those invoices.
Some factoring companies simplify their factoring fees by charging a flat one-off fee for factoring. However, the trend is for multiple fees rather than one fee. Factoring companies will also include other fees into their breakdown of costs. The most common of these is an administration fee or service fee for taking over a company’s sales ledger (or accounts receivable), installing credit controls and running an on-going factoring facility. The administration fee is normally calculated as a percentage of the total value of the sales ledger.
This is also called the factor rate. As mentioned above it is standard to set this at 1.5% to 5% of the value of the invoice that qualifies for prepayment. You will note that the range is quite considerable. This is because companies with larger invoices to factor will be offered lower rates, whereas companies with fewer and smaller invoices will be offered higher rates. This is a reflection of the fact that the fee is determined as a percentage of the invoice amounts.
It should be mentioned that the range of 1.5% to 5% is on top of the central bank base rate for lending. In the UK this is called the Libor rate. It is vital to remember this when looking at factoring costs – when interest rates are high then factoring costs will also be high. You can find a breakdown of the current Libor and other base rates around the world on our home page.
Length of Factoring Period
The amount it will cost a company to get a prepayment for an invoice is determined not only as a percentage of the invoice amount available for prepayment but also by how long an invoice gives the debtor to pay. It is not a separate fee but rather a determinate in what percentage to charge for the discount rate. Thus, the discount rate will be more generous for invoices that mature after 30 days, and higher for invoices that allow 90 days for payment.
An Example of Factoring Fees
A company has an invoice worth £10,000 that is not due for payment for 30 days. Working capital is low and funds are needed as soon as possible to keep the company functioning. The company approaches a factoring company to get prepayment for its invoice. The factoring company will take the business. It proposes charging a 1% service fee and a discount rate of 5%. In return the factoring company will provide a prepayment within 48 hours that is worth 80% of the invoice value.
So, 80% of £10,000 is £8,000. This is the value of the prepayment.
The service fee is levied on the gross value of the invoice. That is 1% of £10,000, which equals £100.
The discount rate is an annual rate. Thus, a daily rate will first be calculated and then applied to the period of factoring required. In this case it is 30 days.
So, it is 5 divided by 365 (days in the year) which equals 0.014% (rounding up). This is the daily percentage rate for factoring.
The daily rate is then multiply by the number of days the invoice is set to run. In this case it is 0.014% times 30 days which equals 0.42%
So, to gather the data together:
Service fee = £100
The discount rate = 0.42% (of the value of the prepayment)
The prepayment = £8,000
To make the final calculation:
The discount rate will apply to the value of the prepayment which is:
£8,000 times 0.42% = £33.6.
Now add the service fee:
£33.6 plus £100 = £133.6
So, the cost of factoring a £10,000 invoice running 30 days with a service fee of 1% and a discount rate of 5% is £133.6.
Other Possible Factoring Fees
Setting up a factoring facility for a company is a complicated legal process that involves negotiation and eventually signing a contract setting out terms and conditions. In recent years, fintech has sought to simplify this process. However, a company looking around for the best factoring deal for its invoices should be aware of several other factoring fees that can be slipped into the terms and conditions of the contract. These include the following.
This is also known as draw fees. It is set as a percentage of the prepayment percentage for an individual invoice. So, if the origination fee is 1% and the prepayment percentage is 80%, then the company selling its invoice for prepayment would receive 79% of the face value of the invoice after the origination fee is subtracted.
Some factoring companies charge a discount rate and an incremental fee. The incremental fee is usually 1% or less of the discount rate. It will be charged daily on the amount of money prepaid for the invoice. Thus, the longer a debtor takes to pay an invoice the more the cost of the incremental fee increases.
Service Fee or Administration Fee
It is common for a factoring company to charge their clients an administration fee for running a factoring facility. This is for costs in setting up credit controls, updating the sales ledger, periodic inspections of the accounts and so on. While it is possible to factor just one invoice, traditionally a large company will use a factoring company for several years and pay an administration fee annually.
Some factoring companies will charge an extra fee called a collection fee if they go through the process of chasing up invoices that are overdue for payment. If the debtor has to be taken to court the collection fee becomes noticeably higher. No surprise there.
This is similar to the collection fee. It is charged as a flat fee for invoices that aren’t paid on time.
Unused Line Fees
A factoring agreement often requires a minimum amount of invoices to be sold for factoring per month. If a company agrees to factor £50,000 worth of invoices a month but one month only factors £40,000 worth of invoices then the shortfall (here £10,000) will be subject to a fee. This fee is often just 0.15%. In the example above that would be £15.
This is not common in the UK, but in other countries it is standard practice to charge an annual fee for maintaining a factoring facility. It is either a flat fee or a percentage of the total amount of prepayments made the previous year.
Transaction Fee, Wire Fee, Automated Clearing House Fee
Whatever way a company receives its prepayment for factoring its invoices, there is often a factoring fee to transfer the money from the factoring company to its client. The factoring company will look to recoup this cost in one off charges. These are essentially banking charges passed on to the client. Fintech and blockchain technology have the future potential to replace bank charges with simpler and cheaper transaction fees.
Credit Check Fees
Any competent factoring facility will run credit checks on its client’s customers. The cost of these checks will sometimes be passed on to the client. A factoring company sometimes charges a prospective new client for the credit checks they run if a deal is reached.
A contract between a factoring company and a company seeking to get prepayments on its unpaid invoices will often include a clause stipulating a minimum time period for using the factoring facility set up on their behalf. If this minimum period is not reached there will be a penalty payment, normally set as a percentage of the size of the factoring facility set up.
The two main factors to consider when looking at the cost for getting prepayments on unpaid invoices are the discount rate and the length of time specified on an invoice for payment to be made. However, there are numerous other factoring fees that a factoring company will try and put in its terms and conditions for operating a factoring facility on behalf of its client.
Clearly, the more your company’s business is worth to a factoring firm the stronger position you are in to negotiate a reduction in the headline costs of the discount rate and the service or administration fee. You will also be in a stronger position to query, reduce or even remove some of the other charges that factoring companies are apt to charge.