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 Is Factoring Expensive?

 

Some may think it costs too much. Let's consider some things.

First, if you need the money and can't get it elsewhere, how much are you willing to pay for what you need?

Second, if you can get it from a bank, perhaps you should. Banks are usually the cheapest source of money, but, not always. Do consider the many possible hidden charges and obligations: Loan Points, Service Charges, Application Fees, Compensating Balances, Legal Fees, Appraisal Fees, Audit Fees, Escrow Fees, Title Insurance Fees, Inspection Fees, Credit Insurance, Environmental Survey Fees, Renewal or Extension Fees, etc.

The cost to a Client for a factored invoice depends primarily on the anticipated risk the funding company is willing to take. This is in turn is relevant to the time value of money as established in the agreement between the parties. They will consider the quality of the invoices, the credit worthiness of the client's customers, expected turnaround time, invoice volume, typical size of individual invoices, the mix of the invoices, and the anticipated overhead.

Roughly speaking one can usually expect that the discount for a 30 day turnaround may be anywhere from about 2.0% to 4%.For an example let us assume a discount of 2% against the face value for a 30 day turnaround and consider the results. (See Note 1.) Let's also assume the Factor advances at the rate of 80% against the face value of the invoices.

If the client factors a $10,000 invoice, the Client receives $8,000 immediately.
Thirty (30) days later the Factor receives the $10,000 from the Customer.
The Factor keeps 2% of $10,000 = $200.00 for its services.
The Factor remits the balance of $1,800 to the client.
Thus the client has received $8,000 + $1800 for a total of $9800 for the invoice.  
If the Client does this every month for 12 months, they have paid $200 x 12 = $2400
for the advanced use of 12 x $8000 = $96,000 during the year.
The actual cost was 2400/96,000 = 2.5% and nothing is owed at the end of the year!
Note 1.
The tendency of Clients is to immediately multiply the 2% by 12 months to annualize it and say the cost is 24% which is false. It's a discount not an interest rate! What if a Client were offering an early pay discount to their customers of say 1.5% in 10 days. One wouldn't then annualize it to 36 x 1.5 = 54% rate! It's only a 1.5% discount!

Factoring is very similar in concept to giving an early pay discount to a customer. The Client is willing to discount the invoice in order to receive the money sooner. With early pay discounts you just HOPE the money will come sooner. With factoring you KNOW when you will get most of the Money!

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