- 16 Jul
How Invoice Finance, Factoring & Invoice Discounting Companies Calculate Their Charges & Pricing
Following yesterday's post: How Invoice Finance Companies Calculate Intial Payment Percentages, I have been asked to clarify how invoice finance companies, factoring companies and invoice discounting companies calculate and set their charges and pricing.
Types Of Invoice Finance Charges
Firstly you should be aware that different invoice finance companies charge differently. Traditionally the charging structure for invoice finance is a service or administration charge (for the service, typically a percentage of turnover or a fixed fee per month), a discount charge (a percentage over base or LIBOR charged on the funding provided and then other charges e.g. electronic transfer charges etc. However, recently there have been a number of invoice finance companies rolling some or all of those charges into one overall fee which again could be a percentage of turnover or a fixed fee per month.
How Invoice Finance Companies Calculate Their Charges
Most invoice finance companies have a pricing formula or pricing matrix of some description. Some are very complicated, some simple. In addition to that there is often a degree of arbitrary adjustment made to the charges that the formula suggests. This can be based on a risk perception, an expected workload or just the desire to win a deal. The pricing formula will also include the return that the invoice finance company wants to make on each deal.
Product related factors may affect workload. For example if the client wants bad debt protection the invoice finance company will price for that and the pricing will be driven by debtor numbers, debtor quality, the level of any first loss clause, bad debt history etc. Equally some invoice finance company's pricing formulas reflect other product factors such as confidentiality, bulk or individual invoice processing or use of electronic systems etc.
Risk & Workload Factors That Affect Invoice Finance Pricing
The pricing calculation will differ depending on the type of invoice finance product.
Factoring Pricing Formula
For instance, with factoring the factoring company will be undertaking a lot of work in providing a credit control service, hence the pricing formula for factoring may factor in workload factors such as:
- Number of invoices per month.
- Number of debtors live (having a balance on the sales ledger) and in total (including those that don't have current balances.
- Average invoice value.
- Number of credit notes (these can add a processing burden which may affect the pricing calculation).
- Actual and/or Projected Turnover - often pricing formulas will include some kind of rachet for the size of the client - a kind of "discount" for larger volumes.
In addition to workload factors there may be some risk related factors that affect the factoring pricing calculation or how it is adjusted (ultimately in extreme circumstances these risks could lead to a decsion not to even quote for a deal) such as:
- Perceived risk of client failure may increase pricing as the factor fears the additional cost of having to recover their funding from the sales ledger. Conversely, a good financial history could result in an attractive risk proposition that the factor will adjust for.
- Perceived risk associated with particular industry sectors i.e. if factors have had good or bad experiences within particular industry sectors they may adjust pricing accordingly.
- Previous facility breaches by the client - if the client has breached the facility covenants (or the covenants of another factor) before the pricing may be increased.
- Ageing of the sales ledger - if the ledger is old the factor may perceive an additional workload and hence price for that and vice versa.
Invoice Discounting Pricing Formula
With invoice discounting, the invoice discounting company will not be undertaking the credit control and so many of the workload factors that affected the factoring pricing formula may not affect or may have a lesser effect on the invoice discounting pricing formula.
Pricing will normally be affected by:
- Client size - i.e. turnover and volume of funding as described above.
The other factors noted in the factoring section may have a slight affect on pricing as they would increase the cost of a collect out in the event of client failure, however, they will have little affect on the day to day workload hence a lesser affect on costing. Some invoice discounters may not make any adjustment for some of these factors.
The risk factors described in the factoring section above could all equally have an affect on invoice discounting pricing calculation and the invoice discounting company is likely to be more concerned with the client's financial accounts and position than a factoring company. In addition there may be other costs that are included in the invoice discounting pricing formula e.g. regularity of audits. This may be driven by the risk policy of the invoice discounter and in some cases the pricing may be adjusted to account for the regularity of audits, this may not be the case for all invoice discounters though.
Invoice Finance Pricing Models
As I mentioned above the construction of pricing models and pricing calculations differs vastly across the industry. In some cases they are very simple and take account of very few of the factors mentioned above, in other cases the opposite is true. Feel free to let me know if you can think of anything else that I have left out!