Why do factoring companies charge minimum fees?
Ian Hepworth
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Ian Hepworth
??Invoice Discounting | Trade Finance | Asset Finance | Business Finance | Acquisition Funding | LinkedIn Top Voice | 22,000 Followers
Minimum fees can frustrate some business owners; however, there is a good reason why factoring companies charge minimum fees.
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Let's start by looking at how a service fee is calculated. The service fee is what the factoring company charges for running the facility. They start with an annual figure they want to recover and then divide that by your projected turnover for the next 12 months.
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As an example let’s assume that the factoring company wants ￡10,000 in service fee for running the facility. If your?turnover?is projected at ￡1m then the service fee applied to each invoice will be 1%. Over the course of a year this will add up to ￡10,000 if you hit your ￡1m turnover. I have used these figures for ease of maths.
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What if you tell the?factoring?company your turnover will be ￡10m? Using the example above, the service fee would be 0.1%. If the business does achieve a ￡10m turnover then the factoring company get the ￡10,000 they need to run the facility. What if the business only achieves a turnover of ￡1m? Then the factoring company would only recover ￡1,000 from the service fee of 0.1% leaving them ￡9,000 short.
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By implementing a minimum fee the factoring company are protecting themselves from this shortfall.
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Typically the minimum fee would be set at 75% of the projected service fee income. So if you have a turnover of ￡1m and the service fee is 1% the projected service fee is ￡10,000. The minimum service fee would be ￡7,500 p.a. or ￡625 per month.
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When structured properly the minimum fee really should not impact on the facility. The service fee you are paying will be more than the minimum fee. If the minimum fee is kicking in then your turnover is lower than anticipated. This may be an unusual month or may be due to a change in the business. If it is a long term change it may be worth restructuring the fees. However, remember that by lowering the projected turnover the percentage service is likely to increase.
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By way an example let’s assume the business turnover drops from ￡1m to ￡500,000. If the service fee was 1% the actual service fee would be ￡5,000 a year so the minimum fees would kick in to charge ￡7,500 p.a. If you were to restructure the service fee it would likely to be changed from 1% per invoice to 2% per invoice to recover the ￡10,000 the factoring company wants to run the facility.
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These examples are just for ease of maths. Smaller facilities are typically cheaper to run, so the actual amount the factoring company wants to run a facility will reduce as turnover drops. It would not remain a static ￡10,000 as used in the examples. Similarly, for larger facilities they will look to charge more.