How to figure out the factor rate for financing small businesses

You know how difficult managing your cash flow can be if you run a small business. In addition to making sure the lights are on, you must also be able to pay for costs, make payroll, and seize any openings for expansion.

Accessing alternative small business financing is one of these crucial chances for success in the face of sudden uncertainty. This article will explain how to calculate interest factors and the distinction between factor rates and conventional interest rates.

You can benefit from tools that can help you manage your business, like merchant cash advance factor rate financing, once you are aware of the financial ramifications of factor rate.

What is a factor rate?

A “factor rate,” also known as a “buy rate,” is a way to describe the amount of interest paid on different kinds of loans. This is a fairly simple calculation that enables you to determine the total cost associated with a potential funding source.

Calculations for factor rate payments are different from more conventional terms like conventional interest rates or annual percentage rates (APR.) Factor rates are described as the extra amount of interest charged on top of a loan’s principal.

As opposed to the interest accrued over time determined by a traditional interest rate or APR calculation. Compared to other types of interest, the interest factor is typically simpler to calculate.

Typically, a factor rate is represented by a number beginning with a value greater than 1.0. The majority of factor rates range from 1.1 to 1.5. The formula for calculating loan factors is X=Y*F, where Y is the loan’s principal, F is the factor, and X is the total amount of principal and interest due. After determining the final principal and interest, factor rate payments are calculated by simply dividing the total amount by 12. (for a yearly repayment period).

Interest payments vs factor payments

Factor rates do not compound over time as interest rates do. Factor rate loans come with a range of payment options. Factor rate loans are fundamentally different from simple interest loans in that they do not compound, making them simpler to calculate.

Merchant cash advance loans make up the majority of interest-rate factor loans. These are cash advances secured by incoming accounts receivable, which may serve as security.

The main benefit of invoice factor loans, also known as merchant cash advance factor loans, is that they are approved more quickly and the application process only takes a few hours or days. Compound interest is included in interest rate payments but not in factor payments.

It is wise for a business owner to carefully review the terms of the overall financing. Even if it seems like a good deal, it might not fit into your budget right now. Always have your accountant and internal finance team review your short-term financing plans.

About merchant cash advance factor rates

A merchant cash advance is a loan taken out against future sales and invoices by a merchant cash provider, such as a credit card servicing business.

The bank or merchant processor establishes a financing factor using this financing tool, which is typically between 1.2 and 1.5. Based on their assessment of the level of risk they will assume in lending to you, your lender determines this amount. This is based on information that the merchant processor will have access to, such as payment and cash flow history.

It’s simple to figure out how to calculate the interest factor. Simply multiply the amount of the advance by the factor to determine the principal that will be required to be repaid on the loan.

Thus, let’s say you require a cash loan of $40,000 as an example. Your merchant processor is aware that you have those invoices for that sum. You have been given a rate of 1.3 by your lender. As a result, you will owe your payment processor $52,000 ($40,000 X 1.3).

When is financing with factor rates the right choice?

In general, factor rates are preferable when you require quick cash, such as to pay bills or payroll. However, when compared to more conventional financing, factor rates are higher.

To understand this structure, it helps to imagine paying a premium for easier access to money.

Because of this, it’s wise to compare options and use caution. Ask yourself if the lengthy process of getting the money you need right away is worth the high-interest rate you will be paying. We’ll talk about how to calculate the interest factor next.

How to calculate the interest factor

Let’s say you urgently require $2500. You can choose to access a loan for either 90 days or three months at a 15% interest rate. We settle on a factor rate of 1.5 for our factor rate loan. 

The formula for the interest rate factor

I= r*A*m/n is the formula for simple interest, where:

  • The annual simple interest rate is r.
  • The loan balance is A.
  • The number of time intervals is m. (in this case, months)

Let’s first examine the loan with regular interest and its recurring payments. We obtain the following figures using this formula:

$375, or $125 paid each month for interest due, is the result of multiplying $0.15 by $2500 times three periods of one month each. Then, add $833.33 for the principal, for a total of $958.33 ($125+$833.33) in monthly payments. The total amount paid for principal and interest would be $2875.00 (3*$958.33).

Calculating interest at a factor rate is much easier. Simply multiply the principal by the factor rate to get the answer. In this instance, the full amount required by the loan terms, $2500 multiplied by 1.5, equals $3750. Factor-rate loans typically have higher interest rates and are immediate and short-term.

Factor rate financing: is it right for your business?

At Gconectpro, we’ve spent years assisting companies just like yours in selecting the best short- and long-term merchant funding solutions. If you require assistance with merchant factor loans or other short-term financing options, get in touch with us. We’d be glad to assist!