The discount rate in a factoring transaction is the fee a factoring company charges to provide the factoring service. It is a percentage of the value of the invoice that a factoring company will charge to process its receivables. A standard discount rate is 1.5% to 2.5% of the invoice value per 30 days.
How a Discount Rate Works
When a business typically factors an invoice, the factoring company can be expected to do two things. One is that the factor will advance a percentage of the invoice and hold the balance in reserve until after the invoice is paid. Another thing the factor will do is impose a service fee, which will deduct from the balance it remits to the company after it collects on the invoice.
This service fee is also called the discount rate, which is the fee the factor charges to provide the factoring service. For example, a factoring company may charge 3% for an invoice due in 30 days. If the invoice’s value is $100, then the discount rate is $3.
Factoring Discount Rate Calculation
Companies engaged in factoring can expect the discount rate to increase for each day, week, or month―depending on the company’s arrangement with the factor―the invoice remains outstanding past the stipulated term.
Below are the calculations for a $10,000 invoice factored for 21 days under three separate fee schedules. To calculate the cost of factoring multiply the number of periods outstanding by the invoice value and the discount rate. The fee is the product of those numbers, and factoring companies will deduct it directly from your invoice.
While the time constraints and total invoices factored are the same in all three examples, the resulting fee is different because of the frequency with which a factoring company calculates it. The more frequently a fee is assessed, the lower the overall fee will be. Because most invoice factoring companies charge fees on a 30-day basis, if debtors pay the invoices sooner, the fee does not change.
Flat Fee vs Variable Fees
A variable fee means that the longer an invoice remains unpaid, the bigger the fees that will accrue for the business. For example, a factor might charge a business 3% for the first 30 days, and 1% for every additional 15 days that the invoice remains unpaid. A flat fee is when the factor charges a one-time fee upfront, which won’t change, regardless of how long an invoice remains unpaid, such as a company might charge a 4% flat fee for the first 60 days.
Factoring companies commonly use both fee structures, and the best one for a business depends on the quality of invoices and the predictability of revenues. For instance, service-based companies, such as those in the trucking industry, are usually offered flat fees because they are considered low-risk to factoring companies.
Average Factoring Rates
Discount rates can range from 1.5% to 4.5% of the total invoice for 30 days. However, the rates a factoring company offers can depend on its historical relationships with the company, the volume of receivables to be factored, and the industry the company belongs to.
Importance of Discount Rates When Selecting a Lender
For most small business owners, price is the most important factor when considering financing. However, for invoice factoring, there are other factors to consider besides price. These include approval times, experience with a specific industry, customer management, and fee structure. The best invoice factoring companies are transparent about their rates and have excellent reviews of factoring services from small business owners.
The discount rate is the fee that a factoring company charges for its services. It is typically declared as a percentage of the value of the invoice. How a factoring company will structure this rate will depend on some key factors about the business, not the least of which is the industry the business belongs to.