Factor Rate

A factor rate is a financial tool used to calculate business financing costs, such as invoice factoring or a merchant cash advance. This rate shows interest owed on business financing and is expressed as a decimal figure, rather than a percentage like interest rates. Unlike interest rates, a factor rate only applies to the invoice amount or the advanced amount (depending on your business’s agreement with the factoring company), and they are fixed – meaning the rate will not change as you pay off your debt.  

How Factor Rate is Calculated 

The lender sets the factor rates, multiplies them by the initial loan amount, and calculates the total amount owed by a business to the lender.These rates typically range from 1 to 2.5 and can be calculated using the following formula: funding amount x factor rate = total amount owed. For example, a lender offers you $10,000 in the form of a merchant cash advance with a 1.2-factor rate. When multiplied together, the total payback amount equals $12,000, meaning you would be paying $2,000 in fees.  

How Lenders Determine Factor Rate  

Since it is typically easy for a business to qualify for alternative financing products, lenders are much quicker to provide funding compared to traditional financing products. Lenders offer better factor rates based upon certain qualities a business may possess. Some criteria a lender may consider before setting your factor rate are: 

Years in business – the longer you have been operating, the more experience it shows you have. A lender will typically offer you a lower factor rate because of this, since you may be considered more qualified and trustworthy.  

Industry– depending on the market conditions, industries may be deemed safer or higher risk than others. If an alternative financing company identifies an industry as higher risk, their factor rate may be higher.  

Business Financial Health – if a business can show a consistent cash flow to current lenders, it can prove they can afford to take on additional debt. It will also show they can efficiently pay back the advance amount, lowering the factor rate. 

Personal Credit History – credit scores are not a huge factor in qualifying for some alternative financing. However, a good credit score will show lenders you can manage your finances. A good credit score may help you to receive a lower factor rate.  

Sales from debit/credit cards – past and present sales will help lenders determine if you can afford to repay your advance. Generally, businesses that have higher sales will be offered lower rates. (generally utilized for merchant cash advance). 

Factor Rates vs. Interest Rates