What is Factoring and Why Use It?

November 13, 2018 by FreightCenter Team
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Guest post by Eagle Express Service

The Principles of Freight Factoring

Freight factoring is a method of invoice factoring that allows trucking companies, including owner-operators, to convert unpaid invoices into cash. Trucking companies and freight brokers tend to use these services to mend the cash flow gap between when they complete their services and when they receive payment from either a shipper or broker. It keeps steady cash flow running through your business, preventing it from being hurt by long turnaround times. While factoring may not be a glamorous aspect of logistics, it is definitely one of the more essential features for maintaining operations of your business. Let’s take a look at who would be considered a prime candidate for freight factoring and how they use it to compliment their business.

Who is Your Ideal Candidate for Factoring?

For factoring companies, there are usually two walks of life that will approach them for their services. First, the owner operator with 1 rig that is usually looking for assistance with his or her cash flow problems. If you’re reading this, then you’re in some way involved in logistics, and maybe even an owner operator, and have experienced the consequential issues of retaining cash flow while operating with a single rig. Let’s face it, the cash from brokers or shippers is not coming in quick enough to keep up with expenses. This type of situation presents the perfect opportunity to work with a factoring company so you can get paid on time and keep business running as usual.

The other scenario is a company with greater scale is looking to streamline efficiency to allow for continuous growth and greater automation of their systems and processes. Once you reach enter into a momentum swing with your logistics business and you’re beginning to take on many new customers, it may be time to seek out some financial assistance. That business loan you took out previously may be running low and is probably becoming inefficient, taking into consideration the outstanding interest rates that are eating away at your profits. At this point, you need assistance from a factoring company to handle the collections of invoices from your customers or brokers in order to free up your time and cash flow to remove you from having to process those payments. By delegating this task, you are now able to focus your efforts on the vital elements of your business: operations, sales, and account management. Every logistics company using factoring for different reasons, but at the end of the day, they work to make streamline aspects of their businesses.

Recourse Factoring vs. Non-Recourse Factoring

Recourse Factoring is an agreement where a company sells its current invoices to a factoring company with the understanding that the company will purchase them back if they remain uncollected. Here’s what Recourse Factoring looks like:

  • Preferred option presented by factors
  • Comes with a lower transaction fee
  • Responsible if the customer refuses to pay their invoices

This option may seem like it provides more advantages to the factoring company than the broker or trucking company, however, the factoring companies ar taking a much lower rate for their services than Non-Recourse Factoring, in which there are some positive implications on the them as well. For one, with the ability for factoring companies to return the invoice if not collected encourages the trucking company or broker to contract with more creditworthy clients to avoid running into these types of issues. Having customers that are good for their money simplifies tasks for your accounting team and makes your business look better overall. Lastly, you’ll want to sell your invoices for next to no discount and receive the largest amount of cash possible in exchange for your invoices.

Non-recourse factoring allows a company to sell its invoices to a factor without the obligation of absorbing any unpaid invoices. Instead, if the customers renege on their payments or pay their invoices late, any invoices are absorbed by the factor, leaving the business unaffected. Here’s what Non-Recourse Factoring looks like:

  • Lesser preferred option by factors
  • Risk-free transactions
  • Higher transaction fee

Non-Recourse Factoring provides significantly less risk to the trucking company or broker because they are not obligated to regain the invoice in case the customer doesn’t pay, which means that the factor is likely to charge a higher fee to manage their risk. This type of factoring may be used on customers or brokers with less than ideal credit history as a form of mitigating risk if they fail to pay either on-time or at all.

Freight Factoring Fees

Depending on numerous additional factors, factoring companies usually take between 3 – 5% of your invoice total. Factors include:

  • The credit history of customers you’re working with
  • Days to pay (does the customer pay on time)
  • The size of the company
  • How many invoices is the company processing per day
  • Additional specifications involving quantities and invoice totals of payments collected

Freight Factoring Process: Start to Finish

  1. Send an invoice to your customer
    No invoice, no approval for factoring
  2. Select a factoring company that you want to designate the invoice to
    Low volume can be more selective of what companies they work with, whereas larger entities often must give the entirety of their invoices to the designated factoring company
  3. Factoring company purchases your invoices for a percentage of their value
    Consider it an investment to ensuring your company continues to run smoothly and keeps involved parties happy
  4. Customer pays the factoring company for the original amount of the invoice
    Some low-volume factoring companies will provide an option that allows for the broker to make monthly payments rather than giving them the full-value invoice
  5. Freight factoring company will collect payment from the customer and send it over after subtracting their fees

As you can see, freight factoring companies may not represent all the glitz and glamour of logistics, but they provide essential services to those who are looking to tackle a career working in the industry. Without access to capital, many of these companies would not be able to scale, let alone get their wheels turning. You got to give credit to where credit is due.

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