The True Cost of Inventory Financing: Factor Rates and What to Compare
Part of the Inventory Funding guide | Updated: April 2026
Understand what factor rates actually mean, how to estimate the effective annualised cost of inventory financing and why repayment speed changes the real cost — so you can compare options accurately rather than being misled by headline numbers.
Why headline rates don’t tell the whole story
The cost of inventory financing is not always what it appears. Two products can have very different advertised rates but end up costing similar amounts in practice — or vice versa. The key is understanding how costs are structured, not just what percentage is quoted.
There are three main cost structures you will encounter:
- Interest rates — used by revolving credit facilities and term loans
- Factor rates — used by merchant cash advances
- Supplier credit or trade terms — sometimes no explicit interest, but the cost may appear through pricing, missed early-payment discounts, or late-payment charges.
Each works differently. Comparing them directly without understanding the mechanics leads to poor decisions.
Interest rates — what you pay on a revolving credit facility or term loan
Interest rates are generally more familiar and easier to compare than factor rates, especially when fees are clearly disclosed.
How it works: If you draw £30,000 from a revolving credit facility at a monthly rate of 1.5%, you pay £450 in interest for each month the balance is outstanding. Repay in three weeks and you pay less. Repay in three months and you pay more.
The key advantage: you only pay for what you use, for as long as you use it. A revolving credit facility is particularly cost-effective when your inventory turns quickly — stock that sells in 30 days costs far less to finance than stock that sits for 90.
Annual Percentage Rate (APR): When comparing interest-bearing products, ask for the APR or an equivalent annualised cost that includes fees. This helps you compare different products and lenders more consistently.
Factor rates — the flat cost structure used by MCAs
A factor rate is used by merchant cash advances (MCAs) and some short-term lenders. It looks simple but works very differently from an interest rate.
How it works: A factor rate is a multiplier applied to the advance amount. If you receive £50,000 at a factor rate of 1.3, you repay £65,000 in total (£50,000 × 1.3). The £15,000 cost is fixed — it does not reduce if you repay early.
Why this matters: Because the cost is flat, repaying faster does not save you money. In fact, it makes the product more expensive on an annualised basis. For illustration, a £50,000 advance at a 1.3 factor rate (£15,000 fixed cost) annualises approximately as follows depending on repayment period:
- 3-month repayment: very high effective APR — annualising the £15,000 cost across only 3 months
- 6-month repayment: meaningfully lower effective APR than the 3-month case
- 12-month repayment: lower effective APR than shorter repayment periods
The exact annualised figure depends on the specific repayment profile and fee structure. Ask the lender for the APR where available, or an equivalent annualised cost including fees. If APR is not quoted, ask for a worked example showing the total amount repayable for a given draw amount and repayment period.
How to convert a factor rate to an effective APR:
- Calculate total repayment: advance × factor rate
- Calculate total cost: total repayment − advance
- Divide total cost by advance to get the flat cost rate
- Annualise based on the expected repayment period
This is why a factor rate of 1.3 is not equivalent to 30% interest.
Why repayment speed changes the real cost
For interest-bearing products, faster repayment means lower total cost. For factor rate products, repayment speed affects the effective APR but not the total amount repaid.
This creates an important asymmetry for inventory businesses:
If your inventory sells quickly (30–45 days): a revolving credit facility can be comparatively cost-effective because the drawn period is short. A factor rate product charges the same regardless of how fast you repay.
If your inventory moves slowly (90+ days): interest costs on a revolving facility rise proportionally, but a factor rate product’s total cost stays fixed. However, the effective APR on the MCA is still high.
For many recurring inventory cycles, a revolving credit facility can be more cost-effective than an MCA, depending on the rates offered — particularly for businesses that buy and sell stock on a regular basis. For a full side-by-side comparison, see inventory financing options compared.
Five questions to ask before you commit
1. What is the APR or effective annual cost?
Do not compare a monthly rate or factor rate at face value. Ask the lender for APR where available, an equivalent annualised cost, and a worked total repayment example.
2. Are there early repayment penalties?
Term loans often carry them. Many revolving credit facilities do not carry early repayment penalties, but confirm before signing.
3. Are there arrangement or origination fees?
A low rate with a high arrangement fee can be more expensive than a slightly higher rate with no fee. Add fees into your total cost calculation.
4. Is interest charged on the drawn amount or the full facility limit?
With a revolving credit facility, interest is typically charged on what you have drawn, not the full approved limit, though facility fees or other charges may still apply.
5. What is the total repayment amount?
For any product, ask: “If I draw £X and repay over Y months, what is the total amount I will repay?” This is the most honest comparison you can make.
This article is general information, not tax, legal, or financial advice — your accountant, solicitor, or a regulated adviser is best placed to advise on your specific circumstances