Treat the advance like any loan: the cash you actually received is the amount borrowed, and each debit is a payment. Find the periodic rate that makes those payments worth exactly what you received, then multiply by the number of periods in a year. A spreadsheet's RATE function does it in one line. An advance of 100,000 at a factor of 1.35, repaid by daily debits over about six months, works out to an annual rate of roughly 126 per 100 outstanding, not 35. Compare advances with term debt on that annual rate and on total payback, never on the factor.
- What you need
- Net cash received, total payback, debit amount, debit frequency, number of debits
- The one-line method
- Spreadsheet RATE function, times debits per year
- Worked example
- Factor 1.35 over six months of daily debits: about 126 a year per 100 outstanding
- What pushes it higher
- Shorter terms, fees taken out of funding, early payoff with no discount, renewals
- What to compare
- Annual rate and total payback, side by side with a term loan quote
Why the factor rate is not a rate
A factor rate states the total the funder will collect as a multiple of the advance. A factor of 1.35 on 100,000 means the business owes 135,000. The 35,000 difference is the cost, and it is the same whether the advance is collected over three months or twelve. That is the first problem: an interest rate prices money per year; a factor rate prices it per deal, and the length of the deal is not in the number.
The second problem is that the balance falls from the first day. Debits usually start within a business day or two of funding, so the business has the full 100,000 for a day or two only. On average over the life of a six-month advance it has the use of about half the money, for half a year. Paying 35,000 for the use of roughly 50,000 for roughly half a year is a very different price from 35 per 100 for a year, which is how a factor rate tends to be heard.
That rough reasoning gives a quick check. Divide the cost by the average balance, then by the fraction of a year: 35 divided by 50, divided by one half, is about 1.4, or roughly 140 per 100 a year. The precise method below lands a little lower, but the quick check already tells you the advance is priced in a different world from term debt.
The calculation, step by step
The annual rate of any borrowing is the rate at which its payments, discounted back to the start, equal the cash received. For an advance, gather five numbers from the agreement and the bank statements.
- Net cash received. The amount that actually reached the account. If the funder deducted an origination, underwriting or other fee from the funding, use the smaller figure. The factor is applied to the gross advance; you had the use of the net.
- Total payback. The purchased amount: the advance times the factor.
- Debit amount. The fixed daily or weekly debit, as it appears on the statements.
- Debit frequency. Business days or weeks. Use about 250 business days a year for daily debits, 52 for weekly.
- Number of debits. Total payback divided by the debit amount.
Then, in any spreadsheet, enter RATE(number of debits, minus the debit amount, net cash received). The result is the rate per debit period. Multiply it by 250 for daily debits or 52 for weekly ones. That product is the annual percentage rate in the sense disclosure laws use: the periodic rate times the periods in a year. Compounding the periodic rate instead gives a higher figure still, so the method here is, if anything, generous to the advance.
For the example: 100,000 received, 135,000 owed, 125 daily debits of 1,080. RATE returns a daily rate of about 0.005. Times 250, that is an annual rate of about 1.26: roughly 126 for every 100 outstanding, over a year.
Same factor, very different prices
Because the factor ignores time, the same 1.35 produces very different annual rates depending on how fast it is collected, and on what came out of the funding. The table runs the same method across the variations owners commonly see.
| Advance of 100,000 at a factor of 1.35 | Debits | Annual rate per 100 outstanding |
|---|---|---|
| Collected over about 12 months, daily | 250 of 540 | About 63 |
| Collected over about 6 months, weekly | 26 of about 5,190 | About 123 |
| Collected over about 6 months, daily | 125 of 1,080 | About 126 |
| Same, but 5,000 of fees deducted, so 95,000 received | 125 of 1,080 | About 149 |
| Collected over about 6 months, paid off in full at the halfway point with no discount | 63 of 1,080, then the balance | About 164 |
| Collected over about 3 months, daily | 63 of about 2,140 | About 248 |
Three lessons come out of that table. The term matters more than the factor: halving the term roughly doubles the annual rate. Fees deducted from funding matter more than they look, because the business pays the factor on money it never received. And paying an advance off early, which lowers the cost of a term loan, usually raises the cost of an advance, because the full purchased amount is owed either way unless the agreement or the funder grants an early-payoff discount.
Renewals: paying the factor twice
Renewals are where advance costs compound out of sight. A funder offers a fresh advance before the first is paid off, and the remaining balance of the old one is netted out of the new funding.
Take the example at the halfway point: 63 debits of 1,080 have been paid, so 66,960 of the 135,000 is still owed. The funder renews at 100,000 and a factor of 1.35, so the business now owes 135,000 again. Out of the 100,000, the funder keeps 66,960 to retire the old advance, and the business receives 33,040. The business has taken on 35,000 of new cost to receive 33,040 of new cash, and the 66,960 it rolled over now carries the factor a second time.
When you compute the rate on a renewal, use only the new cash that reached the account as the amount received. On that basis a renewal is usually far more expensive than the original advance.
Two related cases work the same way. A reverse consolidation funds the debits of other advances over time and charges its own factor on every dollar it advances. And a reconciliation that lowers the debit stretches the collection period, which lowers the annual rate on paper without reducing the total owed; see asking a funder for a reconciliation.
Comparing an advance with term debt
A term loan is quoted the other way round: an annual rate up front, with fees stated separately. To compare the two, bring both to the same basis. The fuller version of this discipline, for any two offers, is on interest rate versus all-in cost.
| Compare | Cash advance | Term loan |
|---|---|---|
| Annual rate | Computed from the debits, as above | Quoted, plus any fees deducted from the proceeds |
| Total payback | Advance times factor, fixed at funding | Principal plus interest over the term, lower if prepaid |
| Payment rhythm | Daily or weekly, before payroll and suppliers | Monthly |
| Paying early | Usually no saving without a negotiated discount | Saves interest; check the prepayment terms |
| Annual payments against earnings | Often more than the business earns once advances are stacked | Sized so earnings cover the payment, commonly at least 1.25x for banks |
The last row is the one that decides whether a business can get out. A lender refinancing advances puts every debit on a yearly basis and sets it against earnings before advance costs, the debt service coverage ratio. A business whose advances collect more each year than it earns can still be a sound borrower for one monthly loan sized to those earnings. How that sizing works is on refinancing cash advances into term debt.
What the funder's disclosure will and will not tell you
A handful of states, California and New York among them, now require many providers of commercial financing to disclose an estimated annual percentage rate when they make an offer, and several others require other cost disclosures. Where you received one, compare it with your own calculation. The estimate rests on the funder's assumptions about how fast receipts will come in; if the debits run faster than it assumed, the real rate is higher than the disclosure.
Where there was no disclosure, the RATE method on your own statements is the most reliable figure you have, because it uses what actually left the account. Keep the calculation. A lender reading a refinance file wants each advance's balance, debit and cost laid out in a debt schedule, and an annual rate beside each advance shows which payoff saves the most per dollar retired, which matters when proceeds cannot retire every position at once. See also MCA refinancing.
Common questions
- Does a factor rate of 1.35 mean I pay 35 per 100 borrowed, per year?
- No. The 35 is the total cost over the life of the advance, however short. Over six months of daily debits it works out to roughly 126 per 100 outstanding a year; over three months, roughly 248.
- Why does my annual rate differ from the one the funder disclosed?
- The disclosure is an estimate built on the funder's assumed collection pace, and it may use the gross advance rather than the cash you received. Your own calculation uses the actual debits and the net funding, so it reflects what the advance really cost.
- Does paying off an advance early save money?
- Usually not. The purchased amount is fixed at funding, so paying it sooner only shortens the time you had the money, which raises the annual rate. The exception is an early-payoff discount written into the agreement or agreed with the funder in writing.
- Do usury laws cap what an advance can cost?
- Advances are written as purchases of receivables rather than loans, and usury limits generally apply to loans. Whether a particular advance is really a loan is a legal question courts decide on its terms. That is for a lawyer; it does not change the arithmetic.
- What figure should I use for the amount received?
- The cash that reached the business's account. Exclude fees withheld at funding and, on a renewal, the balance of the old advance that the funder netted out.