Debtor financing transactions can be structured in various ways. In this article, we explain how the cost of a debtor financing transaction is determined by using the most common transaction structure. If you are not familiar with debtor financing, read “What is Debtor Financing?” before reading this article.
What determines the cost of a transaction?
The interest rates for a transaction depend on two factors: your turnover volume and the risk associated with your invoices. Like most financial transactions, debtor financing is a volume-based business. Companies with high turnovers and low-risk invoices can get lower rates.
When evaluating the risk of your transaction, debtor finance companies consider the following criteria:
- The credit quality of your invoices
- The number of customers you have (also known as concentration)
- The financial health of your company
- Industry-specific issues
Rate components
Finance companies can use numerous costing structures. However, the most common pricing method involves using two fees: the service fee and the discount.
- Service fee: The service fee is one-time charge to every invoice that is submitted. It’s based on the total value of the invoice.
- Discount: The discount fee is charged on the the utilised/advanced funds. It’s calculated daily and charged monthly. The discount is usually a specified percentage rate over the Westpac indicator lending rate (WILR).
Sample transaction
The easiest way to explain how debtor finance interest rates work is to use a sample transaction. Let’s assume that we have a client with the following characteristics:
- Yearly turnover: $1,200,000
- Invoice batch: $100,000
- Advance rate: 80%
- Rebate rate: 20%
- Discount rate: 10% (it’s usually WILR + X%)
- Service fee: 2.2%
- Assume all invoices are paid in 30 days
After delivering services to its customers, the client submits a $100,000 batch of invoices to the debtor financing company. The finance company processes the batch and deposits the advance of $80,000 (80% x $100,000) to the client’s bank account.
After 30 days, the customers pay their invoices in full, which settles the specific batch. The debtor finance company rebates $17,142.47, which is the remaining $20,000 (20% x $100,000) that was not initially advanced, less a fee of $2,857.53.
The cost is calculated as follows:
- The service fee is $2,200: $100,000 x 2.2%
- The discount is $657.53: (10%/365 days) x 30 days x $80,000
To get the total fee, add the service fee and the discount. This sum equals $2,857.53.
Keep in mind that this example oversimplifies the transaction in order to explain it. Invoices don’t get paid in 30 days exactly. Some invoices take fewer days to get paid while others take longer. However, this article should help you understand how debtor financing rates work. Learning this structure will help you determine if factoring or invoice discounting are the right solution for you.
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Note – This article is intended for informational purposes only. The numbers used here are not representative of an actual client.