# One of the most argued topics when discussing costs & rates for invoice factoring professionals and accountants is whether or not it’s an annualised rate or a simple discount applied to an invoice.

Before we start, for those that don’t know APR stands for “annual percentage rate” It’s the interest rate for a whole year (annualised), rather than just a monthly fee/rate that you see advertised with most loan products.

Confusion in how to calculate rates correctly or account for them in company financials is usually based around a lack of understanding. The easiest thing to do is convert invoice factoring fees to annual rates making them easier to account for come end of year and then in turn making the product seem expensive.

Invoice Factoring providers, known as factors or invoice discounters, do not lend money at a rate of interest. They provide funding to businesses by purchasing receivables at a discount from their face value. As such, invoice factoring “rates” are a percentage discount in a sales transaction, not an interest rate on a loan.

##### The miss understanding of how a basic transaction takes place

For example, if you have a \$50,000 invoice that will be paid by your debtor/customer 60 days from now, a factoring company might offer to “purchase” it from you for \$48,500. Now this represents a purchase price of 97% of the invoice value over 60 days. The discount or cost to access money from this invoice is 3%. Now, before you get the money the factor uses a second calculation called the “advance rate” which is usually 80% of the value of the invoice, this being \$40,000 in this case which is provided to you directly as cash up front. The remaining amount is called the “rebate” or “retention” which is returned to you once your customer pays the invoice. The reason that factors advance only 80% cash up front is to mitigate risk, just like a bank does on a home loan they will only lend up to a percentage to allow for fluctuations in the asset. With invoices, it can be any number of factors such as offsets, disputes, returns which cause the invoice to be short paid. There are other factors involved in risk minimisation for factors however, for this calculation we’ll keep it simple.

##### A quick summary:

– Invoice value: \$50,000
– Discount cost for 60 days: 3%
– Advance amount to you: \$40,000
– Rebate (20% of the amount not given to you less the 3%): \$8,500

Total cost to you: \$1,500

*Rates above are for demonstration purposes only

##### Factoring discount rates are transactional rates

The amount of the discount is the factoring company’s fee for the sales transaction – no different than the fees credit card companies charge merchants to advance them cash on their credit card sales. Every time you visit the ATM and you’re charged a \$2.00 fee do you annualize that? You withdrew \$100 and in reality only received \$98.00!

Accountants have been guilty of converting everything to an APR, if you’re a retailer or offer discounts for early payments say for a 3% price discount or early payment every month over the next year, does that mean you will have discounted your product or service 36% by the end of the year?

When invoice factoring is structured correctly based on a company’s turnover and the facility is fully utilized, costs for this product can work out to be 2%-3% of total turnover for a 12-month period. You guessed it, just like discounting your products you’ve just discounted your turnover or gross margin in order access immediate cash flow.

##### What’s the time value worth for receiving money up-front?

Is a 3% fee too much to pay for the ability to recover your working capital immediately?  It’s a simple commercial decision, if you can afford to discount your invoices by 3% and gain use of this capital up-front to invest into growth or have access to liquid funds for supplier payments, wages and tax then by now you’re sold on the idea. If you can’t get your head out of converting it to an APR then it’s not for you.

##### One note on accountants and bookkeepers

A common complaint from companies using invoice factoring is the lack of understanding their accountants and bookkeepers have for allocating payments and accounting for the “discount fee” in records. If you are about to take on a new facility or currently have one then double check they have commercial experience and if not, let me know below for recommendations.

Got a different view? Let me know below or on facebook.com/loandesk