Factoring companies provide capital as a relative portion of the invoice value. The portion they advance right away is called the advance rate and usually ranges from 75% to 95% of the invoice value. Advance rates typically vary based on the industry, due date, volume, and debtor’s credit in a factoring transaction. Small business owners should prefer a larger advance rate when selecting an invoice factoring provider.
How Factoring Advance Rates Affect Costs
Small business owners should include the advance rate, which they can negotiate, when considering the overall cost of factoring. With a lower advance rate, the business effectively is getting access to less capital and, therefore, incurring a higher cost to get access to funding. As a business owner, your financial preference should always be to invest capital in the company sooner, rather than wait for an uncertain future.
How Factoring Companies Determine Advance Rates
The amount of risk the factoring company carries is the primary consideration when setting advance rates. In most cases, the riskier the invoice, the lower the advance rate, and vice versa. Small business owners can increase advance rates by factoring invoices with shorter terms and creditworthy debtors.
Other characteristics that may affect the advance rate include:
- Industry: The less risky and more predictable an industry is, the more likely it is to have a high advance rate. For example, inventory invoices have a lower advance rate than medical invoices.
- Due date: Invoices that are due sooner present less risk to the factoring company that, in turn, allows it to offer a larger advance rate.
- Volume: Companies that factor a large volume of invoices typically have more leverage in negotiating with factoring companies and can receive a higher advance rate on invoices.
- Debtor credit: Debtors that have exceptional credit, for example, major companies like Amazon and Walmart, represent less risk to a factoring company, which increases advance rates.
Every part of a factoring contract is negotiable between the business and the factoring company. Business owners often negotiate the rates and terms of the agreement, but they should also emphasize a higher advance rate. Getting access to capital sooner enables a business to earn a high return by reinvesting and growing internal operations instead of waiting for the money.