Whether the receivable factoring company making you a proposal uses a flat discount, prime plus a margin or other parameters to structure the factoring discount rate, the final factoring rate your business will be offered will depend on your company’s risk level to the factor.
Can a factoring company truly offer you a legitimate proposal without knowing all of the facts about you, your business or your customer base? If we consider the aspects that factoring companies need to take in account to offer a company a proposal the answer to this question would be “extremely unlikely”.
There are many factors that influence your factoring discount rate. The most important ones are the following:
As part of the factoring approval process, and before making you a final proposal, a factoring company needs to analyze your client portfolio and the percentage of businesses each client represents to your company. The decision maker will give special attention to the customer concentration ratio to measure the risk of doing business with your company in case of the default of an account.
Let’s see how this works:
A company with just one customer has 100% concentration. A decision maker will very likely find this situation very risky because if something bad happens to your customer your business will be strongly affected. It is very unlikely that a factoring company will offer you a deal in this case or if it does, your discount rate may be higher along with a lower advance rate.
A company with 100 customers can represent a high funding risk if just one or two of them bring 40% or 50% of the company’ business. This situation significantly increases the risk of doing business with your company.
As a general rule the more customers you have, the lower the customer concentration, and overall risk. Companies with low customer concentration tend to get better discount rates than those with high concentration.
Here is a simple calculator in case you would you like to estimate your company’s customer concentration. (this calculator will work with a portfolio of 10 customers or less, if you have more than 10 customers contact us and we'll calculate it for you)
Customer Concentration Calculator Instructions
Enter only numbers.
The colunm "Percentage of Total Receivables" will calculate the percentage of the total of a/r each customer owes to your company. High percentages mean high concentration.
Note: As most aspects taken in account to calculate your business risk, customer concentration is a relative factor. Only a deep analysis of your portfolio can help a factoring company make a final decision. E.g. if you have a high concentration but your main customers are companies that the receivable factoring company qualifies as low risk, this high concentration rate may have no influence in the definition of your invoice discount rate.
Day sales outstanding (DSO) is your company’s average collection period. As a general rule, the shorter the time it takes to collect a customer's invoice the lower the risk of default and the lower the discount rate your business may qualify for.
Results varie according to the industry your business belongs to. However, a DSO under 1.5 times your payment terms is usually considered a good result.
Here is a calculator to help you estimate your company’s DSO. The smaller your DSO ratio the better the deal you will likely get.
DSO Calculator Instructions
Please complete fields on grey background using numbers only. Do not input $ characters.
The amount of accounts receivable your company plans to factor every month will very likely affect your discount rate in a significant way. Factoring companies incur a number of costs to set-up and manage your account and many of these costs tend to be almost the same whether you sell and invoice for $10k or $100k because their processes are exactly the same.
As a general rule the higher the amount of the invoices you plan to sell, the lower the factoring discount rate you will likely be offered.
Let's learn now about factoring advance rates definition.