What Drives Invoice Factoring Rates?

Invoice factoring is a lifeline for many businesses, offering a quick infusion of cash to address a working capital crunch or service a new account. What does invoice factoring cost, though? And what determines factoring rates for invoice factoring? 
This article pulls back the curtain on key factors that influence factoring rates to give business owners much-needed information to make decisions about invoice factoring. 

What is invoice factoring?

Definitions first, though: invoice factoring is a financial tool for businesses of any size to gain access to working capital. It’s an alternative to bank financing when traditional financing is not an option or may take too long. 
In invoice factoring, a business sells its accounts receivable to a factoring company. The business receives an immediate cash advance, and the factoring company collects the outstanding invoices from customers. Once it does, the factoring company pays the business the balance minus a service fee. 

Factors affecting factoring rates

While “what does factoring cost?” is a common question, the answer can depend on a variety of factors. These can range from the risk the factoring company takes on in collecting on outstanding invoices to the type of factoring. Let’s break down each aspect for more insight on why and how they affect invoice factoring rates.
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• Creditworthiness. Customer creditworthiness is often the most significant factor affecting factoring rates. This is because the factoring company assumes the responsibility of collecting outstanding payment, so they are holding the risk. If your customers are creditworthy, they are likely to pay their invoices, and thus the risk is lower. Therefore, businesses with customers who have historically paid their bills on time are more likely to secure lower factoring rates than those in which the factoring company takes on a higher risk.   ​

• Industry risk. The industry in which your business operates can also affect factoring rates, and for the same reason—risk. Put simply, some industries are inherently riskier than others—think about supply chain volatility or geopolitical upheaval, for example. Firms in these markets may face higher factoring rates stemming from risk like delayed payments, supplier interruptions, and so on. ​​

• Economic headwinds. The economy itself can play a role in factoring rates. During periods of uncertainty or an economic downturn, factoring companies may increase their rates to offset increased risk as customers delay or default on payments. On the other hand, in a stable economy, companies may offer more competitive factoring rates. 
  

• Invoice volume. The number of invoices you plan to factor can also influence factoring rates. If you intend to factor a large number of invoices, it’s possible that a factoring company will offer you a discount. And, if your firm generates a significant number of monthly invoices, you may be able to negotiate more favorable factoring rates. 
  

• Invoice age. Are your invoices aging? Or have they been recently issued? This distinction is important because the age of your invoices can play a role in factoring rates. In general, newer invoices are more desirable because they have a higher likelihood of being paid promptly. Older invoices may drive higher factoring rates because the older an invoice is, the more the risk increases that it will not be paid. 

• ​Factoring type. Factoring rates can also differ between recourse and non-recourse factoring agreements. In recourse factoring, the business engaged with the factoring company keeps some responsibility for unpaid invoices, meaning it shares the risk. Therefore, the factoring rate may be lower. Conversely, in non-recourse factoring, the factoring company assumes 100% of the risk for the uncollected invoices—which is a higher-risk agreement for the factoring company and may drive up factoring rates. ​

• Factoring agreement length. Factoring agreements can range from as little as one month to as long as several years, and the length of an agreement can shape factoring rates. Short-term agreements may have higher factoring rates, while long-term agreements can offer more favorable terms. ​
  

Finally, not all invoice factoring companies are created equal. Administrative and discount fees can shape rates and can vary widely between companies. Some companies may be more flexible with rates and terms than others, too. Be sure to thoroughly review the policies and fee structure when considering factoring your invoices. As a business owner, it’s crucially important that you make the best decision for your business by understanding the factors that determine factoring rates. When you do, you can use invoice factoring as a strategic financial tool to increase business stability.

​Looking for help demystifying factoring rates? We can help. Prairie Business Credit is a national working capital provider to young, growing, or recovering businesses. We offer accounts receivable financing, purchase order financing, and equipment financing. Our company serves both as a trusted financial resource and consultant to entrepreneurs dedicated to building their businesses and ensuring their success.