"Working capital loan cost: what the rate on the offer sheet means"
The working capital lender just quoted you a factor rate of 1.3. You looked at that and thought: 30%? That's not bad. I can handle 30%.
What you didn't realize is that a factor rate and an interest rate are not the same thing. A factor rate is not a percentage of your balance over time. It's a fixed multiplier applied to everything you borrow, up front, regardless of how fast you pay. On $40,000, a 1.3 factor rate means you repay $52,000, a cost of $12,000 baked in from day one.
When you run the actual math, the effective annualized interest rate on a 1.3 factor advance paid back over six months is closer to 109%. Not 30%.
Here is how that number works.
Here is how the math works
Take a $40,000 advance at a 1.3 factor. You owe $52,000 total. The payments come out of your deposits daily, five days a week. On a 6-month term of 126 business days, the daily draw is:
$52,000 / 126 = $412.70 per business day
To find the annualized cost, you need to account for the fact that you're paying on a daily basis against a declining obligation. The effective annualized rate on a 1.3 factor advance paid daily over 6 months is approximately 109%.
You thought you were paying 30%. The advance costs 109% a year.
This is not a trick and it is not a misprint. Factor rates are a different pricing structure, and the difference matters most when you're comparing what you signed against what a bank would have charged.
What a bank line costs, for comparison
A business line of credit from a bank with two years of financials and a DSCR above 1.25 typically carries an interest rate of 7% to 18% APR, depending on the lender, your credit, and the size of the line. That rate applies to the outstanding balance and accrues daily. Pay down the balance and the cost drops.
The comparison is not 30% versus 7%. It is 109% versus 7%. On $40,000, the bank line would cost you roughly $2,800 to $7,200 in interest over the same six months. The advance costs $12,000.
The bank line takes longer to set up. It requires two years of tax returns, clean financials, and a bank relationship. That is the trade the bank is asking you to make for the cheaper money. Owners who know this trade exists before they need the money have time to make it. Owners who need money this week don't.
What the daily draw does to the business
The factor rate tells you the total cost. The daily draw tells you whether the business can handle the payment.
$412.70 a day. If the business deposits $20,000 a month on average, that daily pull is $412.70 against roughly $930 a day in deposits. The advance is taking 44% of average daily deposits before you pay anything else.
That ratio is the number that matters for operating decisions. A short-term gap with a confirmed payoff can survive it. An ongoing operating shortfall cannot, because the advance depletes the cash the business was already short, and next month is the same problem with less runway.
Before you sign the next one
The Quick Money Calculator at zero2ten.biz/quick-money-calculator takes an advance amount, a factor rate, and a term, and converts it into the true annualized cost and the daily draw as a share of your monthly revenue. Run the numbers on any offer before you sign. The math takes about two minutes and the number it shows you is the one you need.
(Illustrative scenario based on the worked example in the Zero2Ten content series.)
Common questions
- What interest rate is typical on a working capital loan?
- It depends on the type. Traditional bank working capital loans or lines of credit can range from roughly 7% to 18% APR. Short-term online loans and merchant cash advances use factor rates instead. A factor rate of 1.3 means you repay $1.30 for every dollar you received. On a 6-month term, that factor rate works out to roughly 109% annualized, not 30%.
- What is a factor rate and how do I convert it to an interest rate?
- A factor rate is a fixed multiplier applied to the amount you borrow. A 1.3 factor rate on $40,000 means you repay $52,000 total, a cost of $12,000 regardless of how fast you pay. To estimate the annualized cost, calculate the cost as a share of the amount borrowed (30%), then adjust for the term. Over 6 months (half a year), that 30% over half a year is roughly 60% simple; with daily payment structure the effective annualized rate lands closer to 109%. The Quick Money Calculator at zero2ten.biz/quick-money-calculator does this math for you.
- Why does a working capital loan from an online lender cost more than a bank loan?
- Two reasons. First, shorter repayment terms mean you're paying the same cost over a smaller window, which pushes the annualized rate up even if the total dollar cost looks modest. Second, many online working capital products are unsecured, faster to approve, and require less documentation, which reflects higher credit risk in the price. A bank line of credit takes longer to set up and requires two years of financials, but the annualized rate is a fraction of most short-term products.
- Does paying back a working capital advance early reduce the cost?
- With a factor-rate product, usually not. The factor rate is set at origination and applies to the full advance amount regardless of how fast you repay. Paying back a $52,000 obligation faster gets the debt off your books sooner, but the cost stays $12,000. This is different from a traditional loan where paying early reduces the interest that accrues.
- When does a working capital loan make financial sense?
- For a short, self-liquidating need with a clear payoff date. A confirmed order you need inventory to fill. A seasonal gap with a known end. In those situations, a higher annualized rate can still be the right call because the money pays for itself quickly. It becomes a problem when it covers an operating shortfall with no visible payoff, because the next month looks the same as this month, and a second advance on top of the first compounds the daily draw against your revenue.
Related reading
"What a merchant cash advance costs"
"A 1.3 factor rate on $40,000 is not 30 percent. Here is how to read the real yearly rate on a merchant cash advance before you sign."
"Why a profitable business gets declined for a bank loan"
"Making money doesn't guarantee a bank loan. Here's what lenders measure, and what you can fix before you apply."
"You applied for an SBA loan. You ended up with a cash advance."
"Nobody lied to you. The system sorted you downward in 72 hours and nobody narrated it. Here is how it works and what you can do before you apply."
"You took a second cash advance to cover the first. Here's the stack."
"A second merchant cash advance to cover the first stacks daily draws. Run the $100K at 1.3 renew math: $60K blended cost, about 24% of a month of revenue."