Factor rate vs APR: converting the number your broker quoted

A factor rate of 1.35 is a complete description of what an advance costs in dollars and tells you almost nothing about what it is worth. It carries the price. It omits the calendar, and the calendar is where the price lives.

That omission is the whole gap between the two numbers. A factor rate measures dollars. An APR measures dollars per unit of time. Leave the term out and the same 1.35 can describe a deal priced near 88 percent a year or one priced near 176 percent, with nothing on the term sheet to tell you which one is in front of you.

This article does the conversion the long way, so you can run it on the deal in front of you.

What each number is measuring

A factor rate is a multiplier. Funded amount times factor equals payback. That is the whole calculation, and it is fixed at signing.

An APR is a rate per year applied to the balance you still have. It moves with two things a factor rate ignores: how fast you repay, and how much of the money you actually kept after fees.

The gap between them is not a rounding issue. On typical advance terms the APR runs three to five times the factor rate premium.

The conversion, worked out

Take a hypothetical advance: $50,000 funded, a 1.35 factor, repaid over 120 business days.

Step one, turn the factor into dollars. $50,000 times 1.35 is $67,500. The cost is $17,500.

Step two, divide into payments. $67,500 over 120 business days is $562.50 per business day.

Step three, find the rate that fits the schedule. You are looking for the periodic rate at which 120 payments of $562.50 are worth $50,000 today. In a spreadsheet that is =RATE(120, -562.50, 50000). The answer is about 0.5245 percent per business day.

Step four, annualize. There are roughly 252 business days in a year. 0.5245 percent times 252 is about 132 percent.

So a 1.35 factor over 120 business days is a cost of 35 percent in dollars and roughly 132 percent a year. Both numbers are true. Only one of them tells you what the money is worth.

The intuition behind the multiple is simple. You never have the full $50,000 for the full term. You start repaying the day after funding, so the average balance you are actually carrying is far below the face amount, while the dollar cost stays fixed.

Term length moves the number more than the factor does

This is the part brokers rarely put side by side. Two hypothetical offers on the same $50,000:

• Offer A: 1.30 factor, 90 business days. Payback $65,000. Daily debit $722.22. Annualized cost roughly 153 percent.
• Offer B: 1.40 factor, 180 business days. Payback $70,000. Daily debit $388.89. Annualized cost just under 100 percent.

Offer A has the lower factor, the smaller dollar cost, and the worse price. It also carries a daily debit nearly twice as large, which is what actually breaks a business.

Run the same factor across three terms and you can see time doing all the work:

Factor	Term	Daily debit	Approx. APR
1.35	90 business days	$750.00	176%
1.35	120 business days	$562.50	132%
1.35	180 business days	$375.00	88%

Same dollars of cost in every row. Same $17,500. The only variable is how quickly it is pulled out of your account.

A reference table for the offer in your inbox

Approximate annualized cost on a hypothetical $50,000 advance repaid over 126 business days, which is about six months:

Factor rate	Payback	Daily debit	Approx. APR
1.15	$57,500	$456.35	57%
1.25	$62,500	$496.03	92%
1.30	$65,000	$515.87	109%
1.35	$67,500	$535.71	126%
1.40	$70,000	$555.56	142%
1.49	$74,500	$591.27	171%

These are illustrations, not quotes. Change the term and every APR in the right hand column moves.

Three ways the quote gets framed to look smaller

Once you know what the conversion does, the framing on a term sheet becomes easy to read.

"It is only 35 points." True as a statement about dollars, silent about time. Thirty five points over five months is not thirty five points over a year, and the whole gap between 35 and 132 lives in that omission.

"That works out to about $2,800 a week." A weekly figure sounds smaller than a monthly one and much smaller than an annual one. Multiply it by 4.33 before you react to it, then divide by your monthly deposits. That percentage is the number that decides whether the deal is survivable.

"Pay it off early and save." On most agreements there is nothing to save, because there is no interest accruing. Unless the contract contains a written early payoff discount, delivering the purchased amount in month two costs exactly what delivering it in month six costs. Ask for that provision in writing before treating it as a feature.

Comparing two offers correctly

Four steps, in this order.

1. Convert both to total dollars owed. Funded amount times factor.
2. Subtract every fee coming off the wire from the funded amount, so you are working with what actually arrives.
3. Divide payback by the number of scheduled remittances to get the periodic payment, then run RATE against the net funded figure.
4. Compare the daily or weekly debit against your average daily deposits, not against your monthly revenue.

Step four is the one that saves businesses. An offer can be the cheaper of two on an annualized basis and still be the one that breaks you, because the debit is larger and the term is shorter. Price and survivability are different questions and both deserve an answer.

Two adjustments that make the real number worse

Fees come off the wire, not off the payback. A $1,250 underwriting fee on that $50,000 advance means $48,750 arrived while $70,000 at a 1.40 factor is still owed. The annualized cost goes from about 142 percent to about 154 percent. Per debit administrative charges do the same thing in smaller increments across the whole term.

Cadence barely matters to price. Converting a daily debit to a weekly one on identical terms moves the annualized figure by well under a point. That does not make cadence unimportant, it just means it is a cash flow question rather than a pricing question. The difference between a daily and a weekly schedule shows up in your payroll week, not in your rate.

Why no one handed you this number

Regulation Z, the rule that puts an APR on the first page of a consumer loan, sits at 12 CFR 1026 and covers consumer credit. Commercial financing is outside it, which is why a six figure advance can close with no rate disclosed anywhere in the file.

States have started filling the gap. California's SB 1235 and the disclosure regulations adopted under the California Financing Law require an estimated annualized rate on sales based financing. New York's Commercial Finance Disclosure Law requires an APR. Utah, Virginia, Florida and Georgia have enacted their own commercial financing disclosure statutes with varying requirements. Whether you received a disclosure depends on where the transaction was made and when it closed.

Four questions to put to a broker before you sign

The conversion only works if you have the inputs, and a term sheet routinely omits two of them. Ask these in writing, in this order, and treat a vague answer as an answer.

1. What is the total payback in dollars? Funded amount times factor. A broker who quotes points but will not put the payback figure in an email is quoting the half of the deal that sounds smallest.
2. How many remittances, and on what calendar? Business days, calendar days or weeks. This is the input that sets the rate, and it is the one most often described as an estimate rather than a number.
3. What actually reaches the account? List every deduction from the wire by name: origination, underwriting, program, ACH, and any per debit administrative charge. The gap between funded and net is the gap between the quoted price and the real one.
4. Is there a written early payoff discount, and where does it sit in the document? If the answer is that the funder is usually flexible about it, there is no discount.

Those four answers give the RATE calculation everything it needs while you can still walk away, which is the only point at which the number changes anything. If the advance is already funded, the same conversion answers a different question: whether the position is merely expensive, which is a pricing problem, or unaffordable, which is not a problem that pricing can solve.