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The cost of factoring

Factoring carries two costs, which are:

The discount charge

The interest cost of the borrowing, which is typically charged at a similar rate to secured bank overdraft lending – i.e. between 1.5% and 3% over bank base rate for a typical borrower.

A service fee

To cover the cost of managing the sales ledger and credit control. This cost will be calculated on the expected workload – i.e. the number of invoices, customers and the industry sector – and will usually charged as a percentage of the company turnover (including VAT). Charges will generally fall in the range of 0.5% to 2.5% per annum.

The above charges are for recourse factoring. Non-recourse factoring will be more expensive than the equivalent recourse deal although the amount of the charge will often fall in the range above, depending on the spread and risks associated with the sales ledger

Invoice discounting is cheaper than full service factoring, as the factoring company will not have responsibility for managing the sales ledger. Typically the service fee for confidential invoice discounting is between 0.1% and 1% of turnover

The “in-between” services such as CHOCS (Client handles own collections), where the client handles collections but the factoring company sends out customer statements and maintains a full duplicate sales ledger carry costs between invoice discounting and full service factoring

In order to reach a valid comparison of the cost of factoring with other forms of finance, it is first necessary to consider the full implications i.e.

 

  • With full service factoring the company is responsible for all the work involved in maintaining and running an efficient sales ledger including the cost of credit searches and enquiries.
  • The outsourcing of the credit collection process should reduce staffing costs and / or valuable management time.
  • As the factoring company collects and banks customer cheques, bank charges will be lower.
  • Further cost savings will result from the factoring company posting customer statements and chasing overdue debtors on the telephone.
  • There are no annual renewal fees or management charges.
  • The discount charge is only charged in respect of funds in use.
  • With cash available it may be possible to take advantage of a discount for early settlement of creditor invoices.
  • Consider the opportunity cost of sales lost due to lack of cash.
  • Tighter credit control procedures should reduce the incidence of bad debts.
  • Factoring companies have efficient credit collection procedures that should reduce debtor turn and therefore the interest cost of carrying debtors.

It is clear from the above that the most compelling arguments for factoring result from the needs of a rapidly growing business.

For a business with static sales and which already has good credit management procedures in place, the evidence is much less persuasive unless it simply cannot get its traditional bankers to extend facilities to the level required. Even then the first consideration should be (much cheaper) extended credit from suppliers if this can be negotiated

An example of the cost of factoring can be given using case study CF1 where a business with an overdraft facility of £100,000 changed its financing to full service factoring

Prior to taking on factoring the company utilised its overdraft fully and the annual costs were

  • Interest £9,000.00
  • Renewal fee £1,500.00
  • Other management charges£650.00
  • Total charge £11,150.0

The service charge for the factoring arrangement was charged at 0.6% of gross turnover and thus cost £7,000 per annum. The company achieved savings of around £2,000 per annum in the bank renewal fee and charges but nevertheless the overall cost of the arrangement was an additional £5,000 per annum. The interest cost and the discount charge were very similar

What this does not take into account was the fact that, with the benefit of the arrangement, the company was able to increase its turnover by 50% and profits by 400% – after interest charges. Thus the additional charge of £5,000 was justified many times over

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If you are considering factoring for your business then please contact us for a no-obligation quotation.