Last Updated on February 23, 2021 by Mike Yon
Freight companies take a lot of work, and often see gaps in income while waiting for clients to settle up. For many companies, those interruptions in cash flow cause big problems.
One possible solution is freight factoring. As an alternate financing option, factoring can help you maintain seamless business operations by streamlining your invoices and income. Before diving into an agreement with a factoring company, it’s a good idea to learn how the system works.
What is Freight Factoring, and How Does It Work?
Typically, trucking companies invoice customers for their services and wait a set amount of time for payment. Unfortunately, waiting for payment doesn’t always work with business needs, and the company needs cash to stay afloat.
Freight factoring, or trucking factoring, is an alternative form of financing for transport companies. Transport companies can use unpaid invoices to get cash advances to cover shortages until they receive payment for services.
How Freight Factoring Works
Freight factoring sounds similar to a loan, but it’s quite different. Instead of a bank asking for collateral, the freight factoring lender uses a trucking company’s existing, unpaid invoices.
The system is quite simple, but like any financial agreement, there are some fine print items to pay attention to, like fees. We’ll explore that more later, but for now, let’s look at the process.
If you need money fast and you’re waiting for a shipper to pay you for your service, you can contact a factoring company (also known as a lender). Keep in mind, you have to invoice the customer before contacting a factoring company.
Once a lender accepts your invoices, two things happen. First, the factoring company advances you 80% to 90% of the invoice value in as little as 24 hours. Second, the lender takes responsibility for collecting the outstanding amount from your shipper.
The shipper pays the factoring company the full amount of the invoice. Once the lender receives full payment, they issue you a rebate for the remaining amount of the invoice, minus their fees, of course.
Pros and Cons of Freight Factoring
As with everything in life, there are upsides and downsides to freight factoring. The process gained popularity in recent years for a good reason, but it’s not without issues.
Companies would not participate in factoring agreements if they weren’t viable solutions. As an alternative funding opportunity, there are some significant benefits for certain types of companies.
- Fast funding is one of the biggest perks. Your advance may be available within 24 hours instead of the weeks it takes to secure traditional loans.
- A questionable credit history isn’t a big deal because your invoices act as collateral. It’s so easy to qualify for freight factoring that even start-ups with limited credit histories can secure funding.
- You can grow your business faster with cash in hand. It means you don’t have to turn down new business while waiting for existing customers to settle up.
- Since the factoring company takes on the burden of collecting from customers, the trucking firm is free to handle other business operations without gaps in cash flow.
When it comes to financing, you don’t want to jump into anything without having all of the facts. There are a couple of downsides to embracing freight factoring. However, if you’re prepared for them and account for them before entering an agreement, they may not cause you trouble.
- These agreements are free, and the fees can be expensive. Make sure you can cover the fees and not lose money on the deal.
- If your customer doesn’t pay, your lender raises your costs on future deals.
- You lose some control over the accounts receivable process because the factoring company takes over the invoices with your customers. It also means your customer pays the factoring company, not you.
- Some agreements include provisions that you must commit to sending all of your invoices to the factoring company.
What Types of Businesses Should Consider Freight Factoring?
Only you can decide whether or not freight factoring is right for your company. For the most part, high-volume businesses and owner-operators of single trucks have the most to gain from factoring.
If you’re not sure, there are some questions you can ask to help reach a decision. Answering affirmatively to any of these questions is a good indicator that you could benefit from working with a freight factoring company.
- Are your customers slow to pay up?
- Do your customers have any credit history issues?
- Is the intermittent cash flow preventing business growth?
- Are you having difficulty paying your vendors on time due to cash flow gaps?
The Finances Behind Freight Factoring: Rates, Terms, and Qualifications
What did you decide? If you’re serious about freight factoring, it’s time to get down to numbers and take a hard look at what it could mean for your company.
First, it’s necessary to note that most factoring companies determine rates, terms, and qualifications based on the size of your company. To that end, you fit into one of two groups, low-volume factoring or high-volume factoring. While the process is similar for both, there are a few distinct differences.
Looking at Rates
Low-volume (smaller) companies do less business, so they ask for lesser advances in factoring agreements. If you’re a smaller company, you can expect rates starting at 0.25%, though they typically range from 2% to 5%. Watch for a one-time set-up fee for your first factor.
Larger (high-volume) companies that factor larger amounts (up to $20 million per month), can expect rates starting at 0.5% and capping at 5% on average. There may be a start-up fee plus additional penalties if the business doesn’t meet a monthly minimum.
Typical Factoring Terms
Freight factoring terms are a bit more complicated because there are some different options available depending on the business size. Once you grasp the terminology, it’s easier to understand how factoring companies establish the terms of the agreements.
Spot Factoring vs. Contract Factoring
You know that when you factor a freight invoice, the factoring company receives payment from your customer. Do you have to factor all of your invoices once you enter an agreement? What happens if you only want to factor some invoices and keep others for yourself?
Generally, smaller companies use spot factoring, which allows them to pick and choose which invoices to factor. Larger companies may have an option for spot factoring, but generally, their agreements use contract factoring, which means they must factor all of their invoices.
Recourse vs. Non-Recourse Agreements
Another difference between low-volume and high-volume trucking companies is the opportunity for non-recourse agreements. Most factoring agreements fall under the recourse category meaning that the trucking business agrees to buy back any unpaid invoices.
Larger and high-volume trucking firms may have the option to accept a non-recourse agreement. Non-recourse means that the trucking company isn’t responsible for invoices their customers fail to pay. These agreements generally include additional stipulations and much higher rates.
How to Qualify for Freight Factoring
As you would expect, factoring companies have slightly different qualification standards depending on the size of the trucking firm. While it’s generally easy to secure a factoring agreement, there are still some standards.
Regardless of the size of the trucking company, factoring agents expect invoices to come due within the next 90 days to qualify. Factoring companies also review the creditworthiness of all customers and may pull credit scores before reaching an agreement with any size of a trucking firm.
Qualifications for Low-Volume Trucking Companies
For these purposes, factoring companies define smaller companies as those seeking to factor up to $30,000 per month. There is some flexibility with the numbers, but these represent typical averages.
- The trucking company should have a credit score of at least 530.
- It takes a day or two to qualify.
- The trucking company needs to be in business for at least three months.
- The trucking company should have an average annual revenue totaling $100,000 or more.
Standards for Larger Companies
Trucking companies that expect to factor more than $30,000 per month qualify as high-volume clients. The qualifications account for the difference in capital and expectations of the company’s history.
- Factoring companies don’t usually pull credit scores on larger companies, but they do focus on the creditworthiness of their customers.
- Though they don’t look at company credit, the trucking business has to exist for at least two years to qualify.
- It takes longer to qualify and establish an account. Expect the process to take at least two days, but it may be a week before you receive approval.
- The average annual revenue needs to be $600,000 or more.
The Bottom Line
Freight factoring is an increasingly popular method to streamline invoicing and maintain steady cash flow for trucking companies. For some companies, it’s also an option for offloading their accounts receivable functions to a third party so that they can focus on other business needs.
Can you absorb the fees and rely on your customers to pay the factoring companies on time? If so, freight factoring may solve some issues for your trucking business.