The Cost of Factoring # 2

In my last post I continued to explore the differences among the basic types of factoring relationships.

The traditional full-line factoring relationship typically involves more money, minimum required transaction volumes, minimum required commitment periods, a broad array of services and better credit.

Spot factoring, on the other hand, typically involves smaller transactions, no required minimum time periods, no required volume commitment, weaker credit and, essentially, a single service.

The cost in time and effort to establish a traditional factoring relationship can be recaptured over a known minimum period of time and volume of transactions. This leads to a pricing structure that is more closely related to the factor’s cost-of-funds. Frequently these relationships will require a basic cost-of-money element stated in terms of a spread over the prime rate, but they will also typically include a range of service fees.

For example: there might be a fixed additional fee applied to each invoice purchased, a processing fee for collections, an accounting and reporting fee and fees for all money transfers. An annual account maintenance fee might include the costs of analyzing required updates of the client’s financial statements and new credit reports and UCC searches.

While the stated cost-of-funds in such a relationship is an easily understood item, the total cost of the relationship has to be evaluated in light of the charges for the various services provided.

The spot factoring company, on the other hand, because it’s pricing is predicated on a single transaction rather than a longer-term commitment, will most often quote an “all-in” fee based on the face amount of the invoices being purchased.

The cost-of-funds element of the spot factor’s pricing will typically be a smaller component of the total cost than would be the case for the traditional full-line factor. That is because the spot factor has to accept the possibility that it will complete only one transaction with a prospective client. If that is, in fact, the case, the time and effort required to establish the relationship and close that single transaction will be a much larger element of its cost than the cost-of-funds itself.

In fact, the spot factoring company will almost always lose money on a single-transaction relationship.

We are all accustomed to converting costs in a financing relationship to an annual percentage rate. And most of us have certain benchmarks; like the interest rate on a car loan, a home mortgage or a credit card; against which we measure those costs.
In factoring relationships those benchmarks are of minimal value.

In the case of full-line factoring, the benchmarks have minimal value because of the range of services provided in addition to the value of the funding itself.

In the case of spot factoring, the benchmarks have little value because the nature of the relationship and the costs associated with it bear little resemblance to the relationships in our normal benchmarks.

Especially in the case of spot factoring, the cost that is most important to analyze and understand is OPPORTUNITY COST.

That is, answering the questions:

a) What is the value of the opportunity that the factoring arrangement allows me to pursue that I could not otherwise pursue? or

b) What costs can I AVOID by having the money owed to me NOW rather than, say, 45 or 60 days from now?

I’ll address the opportunity cost issue in my next post.