Factoring and invoice discounting, both methods of invoice finance, can be an excellent way for small and medium-sized businesses to get their hands on a quick injection of cash. But before you can consider either of these methods as a potential finance stream, it’s important you understand the costs.

The good news is that the soaring popularity of invoice finance over the last couple of years has led to a dramatic increase of providers in the UK. That has driven down the price of this finance facility as all those providers compete for a slice of the pie.

This is our breakdown of the costs to give you a better understanding of the product and help you rule it in or out as a potential finance stream.

How is the Cost of Factoring Calculated?

The costs of a factoring or invoice discounting arrangement tend to change from one provider to the next and are often negotiable. As the costs can differ quite significantly, with specialists in a particular industry often the most competitive, it’s essential you contact several providers for a quote.

The costs you’re likely to see included in the quote are:

  • Discount charge
  • Credit management (service) fee
  • Additional costs for services such as credit protection
  • Notice period to end the service – some providers have notice periods of up to a year which could be costly for your business

What is a Typical Factoring Fee?

If you’re factoring £20k in invoices, and you choose a company with a 3% discounting rate, you will receive £16k up front, then £3400 after 30 days when the invoice is paid.

You will have paid a £600 factoring fee.

A Breakdown of Factoring and Invoice Discounting Costs

  • Discount charge

The discount charge works in the same way as bank interest, just like you’d pay on a bank loan, overdraft or business credit card. It is the cost, calculated as a percentage of the invoice value, for releasing the cash to you. This charge will be applied usually on a weekly or monthly basis and will typically range from 0.5 – 5 percent. Generally speaking, the higher the value of the invoice you want to release funds from, the lower the discount charge will be. For that reason, it often represents better value to release funds from higher value invoices.   

  • Credit management fee

The provider will also charge a fee to cover the credit management and administration costs associated with delivering the facility. The credit management fees for invoice discounting are typically lower than factoring because you retain the responsibility for collecting and managing your own debts, so there’s less work for the invoice finance provider to do.

The credit management fee for invoice discounting could range from 0.2 – 0.5 percent of gross turnover, while typical fees for a factoring agreement are likely to be between 0.75 and 2.5 percent of turnover.

  • Credit protection charges

A credit protection fee will only apply in non-recourse factoring arrangements, where the finance provider is liable for any bad debts (invoices that are not paid). The amount charged will depend on the level of risk your debtor book represents, but will typically range from 0.5 – 2 percent of turnover.  

  • Notice period to end the service

This is the amount of notice an invoice finance provider requires in order to bring the arrangement to an end. This is typically a period of around three months but it can be as long as a year. During this time all of the charges will have to be paid.

What Affects the Cost of Factoring and Invoice Discounting?

There are a number of different factors that will impact the price you pay for a factoring or invoice discounting facility. As a very simple rule, the greater the volume and higher the value of your invoices, the lower the costs as a proportion of your turnover will be.

These are some of the factors an invoice finance provider will take into account:

  • How often you use the facility – The biggest determiner in the amount you pay is likely to be the number of invoices you want to release funds from. The more invoices that pass through the facility, the lower the rate will tend to be.
  • The value of each invoice – Whatever the value of an invoice, the effort required to process and collect the payment (in a factoring facility) will be the same. Therefore, the costs are proportionately lower on higher value invoices.
  • Your industry and sector – Some industries are inherently more risky than others. If you operate in an industry where non-payment is more common then the credit protection charge for a factoring facility will rise.  
  • The track record of your clients – If the clients you invoice are established, reliable firms with a track record of making payments on time then the cost of a factoring agreement will be less than it would if they had a poor credit history.
  • The size of your business – Invoice discounting providers generally prefer to work with businesses with a larger turnover and an established credit control process in place. That’s because the business retains responsibility for collecting payments.

A factor is more likely to be open to working with smaller businesses with less turnover because they collect payments on the business’s behalf, which reduces the risk. Whatever the size of your business, being able to prove the stability of your business and reliability of your debtors may help you negotiate lower costs.

Is Factoring Receivables a Good Idea?

The costs once associated with factoring and invoice discounting arrangements used to mean that invoice finance was considered to be a credit source of last resort, only accessed when bank overdrafts and credit cards were not available. However, now all that has changed. The surge in competition in the industry has pushed costs down and brought service levels up.

When considering whether factoring and invoice discounting are a potential credit source for you, it’s essential to weigh up the costs of alternative methods of finance too. These days, it’s often the case that the cost of factoring and invoice discounting are similar or even less than other methods or short-term finance. When compared with the costs associated with a cash-flow shortfall, such as an inability to make your own payments on time, it can represent excellent value.