Invoice factoring / discounting funding terms
What does it cost? Understanding the charging structure
It is wrong to assume that this invoice factoring or discounting finance is expensive as the product is priced according to risk specific to your business and charges will vary from business to business.
There are three principal charges to be aware of:
The Service Charge & Minimum Annual Service Charge
The service charge, administration charge or credit management fee as it sometimes called will usually be a percentage of the value of the invoices that are funded. This is an ongoing fee and in the case o factoring provides you with the facility and a credit management service. In the case of invoice discounting this provides the finance facility and the cost of the monitoring/auditing.
There is normally a minimum service charge quoted which is either charged monthly, quarterly or annually and is calculated on turnover. This provides the factor with the minimum income they expect from the facility and serves to protect them in the event that their client's turnover falls short of the expected financial projections.
Typical factoring fees range from 0.75% to 2.5% of total turnover whereas invoice discounting fees range from 0.2% to 0.5% of turnover which are significantly less but remember only finance is being provided.
The Interest or Discount Charge
The interest or discount charge works in a similar way to an interest calculation and is based on the funds in use. This charge is calculated at an agreed margin and typically ranges between 1.5% and 3% over bank base rate.
There may be other charges which may or may not be explicitly stated within the quotation - it is prudent to question the factor about these. These charges could include:
- A re-factoring charge (an additional charge on debts reaching a certain age)
- Charges in respect of electronic transfers or returned (bounced) cheques
- "Trust Account" charges applied to the transactional activity of your invoice finance account
- Small additional charges for credit insurance are also made if non-recourse factoring is used. These will range from 0.5% to 2% of turnover depending on the level of risk the factor assigns the arrangement
- Arrangement Fee or Commitment Fee. There may be an arrangement fee or commitment fee. Normally, an arrangement fee refers to a one off fee that is paid and not refunded whilst a commitment fee may be refunded after commencement. You should question the factor about the exact nature of such fees
Understanding the funding proposition for invoice factoring or discounting
Calculation of availability
On commencement of an invoice factoring or discounting agreement the finance provider will make available an early payment or prepayment percentage of your agreed outstanding sales ledger which provides the initial cash injection on day one.
From that point onward you simply notify the value of the sales invoices that you have raised each day, week or month. Based on the invoice values and cash received, the factor will create available finance for you to use as you required.
It is not uncommon as the facility develops to be notified by the factor that certain invoices are "unapproved" for funding. These "unapproved invoices" will affect the actual level of funding that you are able to access and may include invoices still outstanding after 90 days or invoices raised in advance of delivery. It is essential to question the factor about how they calculate the available level of funding and understand the implications for your business.
In addition to the above, the invoice factoring or discounting facility may be subject to a restriction against major debtors (prime debtor restriction or concentration reserve) or there may be individual funding limits imposed in respect of each debtor, or credit limits if your facility is non recourse (meaning it includes bad debt protection).
If your agreement is for recourse factoring, there will be a recourse period after which funding is withdrawn. If it is non recourse, there will be a period after which the factoring company will pay the balance of any covered debt to you under the terms of the bad debt protection that they are providing (note for further detail on recourse and non-recourse factoring you can click here.
The invoice factoring or discounting funding terms may also state the maximum value of the facility often known as a 'payment ceiling' or 'refer limit'. This is the maximum level of liability to the factor that you may reach at any time. Bear in mind that this is only the maximum ceiling and does not reflect the level of funding that you can expect to receive.
- Business finance services - A Guide to Factoring and Invoice Discounting
- What is Invoice Discounting?
- What is Factoring?
- Is factoring/discounting suitable for our business?
- Online Quotations for Factoring - A Word of Caution
- The Advantages and Disadvantages of Factoring and Invoice Discounting
- Recourse and Non-Recourse Factoring
- Bad Debt Protection/Credit Insurance Protection
- Export Factoring/Discounting
- Understanding the Funding Proposition
- Security Required by a Factor or Discounter
You may also find our business finance glossary of terms useful.