Why a factor rate is not an APR

A quote of “1.20” can look reassuringly small beside an annual percentage rate. The numbers describe different things. A factor quote tells you how a stated amount becomes a repayment total. An APR expresses financing cost on a yearly basis, using rules that account for the money received and the payments made over time.

Before comparing them, translate the factor into dollars. Then find out how much money actually reaches the business and when it must leave again.

What does a factor of 1.20 mean?

Suppose an invented financing offer defines its factor this way: multiply a $10,000 advance by 1.20 to get the required repayment. That produces $12,000, or $2,000 above the advance. Assume for now that the business receives the full $10,000 and pays no other fees.

The calculation is useful. It establishes a dollar commitment. But $2,000 divided by $10,000 is 20 percent of the original advance, not automatically a 20 percent annual borrowing cost. Nothing in that division says whether repayment takes three months, six months or a year. It also says nothing about payments made along the way.

The Federal Reserve's March 2025 discussion of small-business financing identifies factor pricing as a source of confusion in merchant cash advances. A factor quote should not be compared directly with an interest rate or APR. The label on the offer does not supply the missing payment terms.

The same $2,000 can buy different amounts of time

Keep the invented offer unusually simple. The business receives $10,000 at the start, makes no interim payments and pays $12,000 exactly one year later. The cost over that year is 20 percent of the money received.

Now change only the repayment time. The business still receives $10,000, but pays the entire $12,000 exactly half a year later. The dollar cost remains $2,000. The business has had the money for half as long.

For this second example, an illustrative effective annual rate is 44 percent: 1.20 multiplied by 1.20, minus 1. The calculation converts a 20 percent half-year cost into a compounded annual equivalent. It does not say that the business actually borrowed twice or paid $4,400. Its stated payment remains $12,000 at the half-year point.

These are deliberately simplified cash flows, with time measured in exact year fractions. The 44 percent figure is an effective annual rate for that example, not a legally defined APR or an estimate for an actual offer. Regulation Z's APR definition relates the amounts and timing of funds received to payments made and specifies calculation methods. A compounded annual equivalent should not be relabeled as that disclosure.

Payments along the way change the calculation

The single-payment example gives the business access to the entire advance until repayment. Many real offers work differently.

If the business starts returning money daily or weekly, it does not keep the full original amount throughout the term. A calculation that divides the flat cost by the advance and then scales it by the number of months misses those earlier payments. A proper annualized comparison needs each payment's amount and timing, not just the final repayment date.

For a revenue-linked arrangement, the repayment date may itself depend on sales. The Federal Reserve describes advances repaid from a share of sales or revenue, sometimes collected automatically. Faster sales can return the money sooner. If the total amount payable stays fixed, faster repayment means a higher annualized cost for the shorter use of the funds. The actual contract determines whether that total stays fixed and how payments adjust.

An estimated annualized figure therefore needs its assumed sales and payment schedule beside it. A slower-sales scenario can have a different annualized result while leaving the business with less revenue to meet its other costs. The lower rate number would not, by itself, show an easier situation.

Check the deposit as well as the advance

Return to the $10,000 offer with $12,000 required in repayment. This time, suppose the provider withholds a separate $500 fee at funding. The business receives $9,500, not $10,000.

With no other cash flows, the gap between cash received and cash repaid is now $2,500. Calling the offer a “$2,000 cost” would omit the withheld fee. Dividing $2,500 by $9,500 gives about 26.3 percent, but that is still a cost-to-cash-received ratio, not an annual rate without a repayment schedule.

Keep the fee's treatment explicit. If the quoted repayment already includes a particular fee, do not add it again. If part of the proceeds pays an older obligation, record that separately from a financing charge and from new cash available to spend.

This distinction also appears in formal disclosures. New York's closed-end commercial financing statute separately identifies the financing amount, disbursement after withheld fees, finance charge, repayment total and payment frequency for offers it covers. Those are useful fields for reading a quote even when that particular law is not the governing disclosure framework.

Ask what an early payoff actually changes

Paying sooner does not establish, on its own, how much the provider will accept. Ask for the amount due on the proposed payoff date and whether paying then reduces the remaining charge or adds another fee. Keep the answer in dollars.

If the repayment total remains $12,000, finishing earlier does not turn the original $2,000 charge into a smaller charge. If the contract offers a reduction, use that actual reduction in the comparison. The original factor alone cannot answer the payoff question.

The CFPB's explanation of interest rates and APR distinguishes the interest rate from a broader measure that includes additional loan fees. It concerns consumer lending; it does not mean every business offer must use the same disclosure. The Federal Reserve notes that small-business disclosure requirements vary by state. Do not infer the requirements for a particular agreement from the pricing label.

Read the quote in dollars and dates

Before treating two quoted rates as comparable, establish:

• The stated financing amount and the net cash the business receives.
• Every required fee and whether it is withheld, separately paid or already included in repayment.
• The total repayment and the amount and timing of payments, including any sales assumptions.
• The payoff amount on a date you might actually use.
• The method and assumptions behind any APR or other annualized figure supplied.

The separate question of whether the payment fits still matters. The full loan-cost comparison follows a payment through its complete schedule. Here, the first task is narrower: make sure two price labels describe the same kind of measurement before choosing between them.

Read the decisions behind the numbers

Infinite Upside: Building Wealth With Room to Live, by Vijay Sheth, is a business memoir about acquisitions, negotiation, ownership and the work that follows an agreement. This factor-rate example is separate from the book. If you enjoy looking closely at what a deal asks of the people making it, read the opening of Infinite Upside, then choose a way to read the book.