If you own a business, there may come a time when you need a financial solution to a challenge that arises. What type of business funding will you choose? Moreover, what sort of interest will come with it?
Just like any other loan or line of credit, the money you borrow comes with a cost to finance. Many people are familiar with the term annual percentage rate (APR), an interest rate that is commonly associated with credit cards and other consumer funding options. Depending on the type of business funding you choose to fulfill your business’s needs, the cost of financing may come in the form of APR or factor rate. Unfamiliar with factor rate? You’re not alone. An APR and a factor rate operate so differently that they are not meant to be compared side by side. However, you should understand the differences because you’ll likely encounter both as you research funding options.
Factor rates are specific to business funding and are typically based on the following:
- Your industry
- How long you have been in business
- Stability of your sales and growth
- Average monthly credit card sales
Factor rates are expressed in a decimal figure rather than a percentage. Factors rates typically range from 1.1 to 1.5, based on the elements above.
In order to determine the total amount you’ll need to pay back in the end, you’ll need to multiply your factor rate by the total amount that you were funded. The payback amount will be determined by your payment frequency and the term. This is different from an APR, which is always annualized. See the example below to see factor rate in action.
Finance terms can be confusing, especially when you are familiar with personal finance terms and still learning those associated with small business funding. If you’re ever in doubt about your factor rate or how your interest is being calculated, reach out to your lender or financial advisor for clarification.