Factoring Myth 2: Factoring Fees are much more expensive than bank loans
The insidious myth
This myth is insidious and causes many business owners who could benefit from factoring to discard it as a means of finding working capital. To bust the myth, think in terms of the how you get paid for your product or service.
Cash flow example
Let’s say you own a manufacturing company that produces 1000 green gizmos for your customer, Company XYZ. The payment cycle goes like this:
- Manufacture
- Ship
- Invoice
- Wait for Payment
Let’s say the invoice is $10,000. That amount show up in your financial records as “Accounts Receivable;” that is, money owed but not yet collected.
Factoring fee vs bank interest
When you sell that invoice to a factoring company they will discount the value of the invoice by a certain percentage, but you get the immediate use of your money. You don’t need to wait 30 days or more. That discount will typically range from between 3% and 6% – depending on a number of variables. (This is similar to the range of credit card merchant fees.) For purposes of this example we’ll assume a fee of 4% of the face value of the invoice.
If you have ten customers each of with buys 1000 gizmos in January. You will have 10 separate invoices each for $10,000 or $100,000 gross volume. You can sell each individual invoice to you factoring company and you will pay the same fee for each invoice: 4% of the face value. If you factor $100,000 in invoices every month for 12 months ($1,200,000) you will have paid 4% of the face value as a fee.
Confusion with a Bank Line of Credit
Many people confuse the factoring purchase fee with a revolving line of credit. They mistakenly calculate that at 4% per month you are paying 48% annualized interest on $100,000. But you didn’t receive $100,000. You received $1.2 million.
But let’s take this one step further. If you have a bank line of credit and it is always at $100,000 of funds drawn, you would be paying something like 3% or 4% per month on the unpaid balance anyway. So one way or the other, the factoring fee is not as high as most people mistakenly believe.
