Factoring can be a great way for small businesses, especially trucking companies, to manage their cash flow effectively and not devote valuable time that can be better spent hauling the next load because you are chasing down a late payer.
Factoring is the process of selling accounts receivables in exchange for a small fee that is deducted by the factoring company. In exchange for the fee, which can range from about 3% of the receivable to 10% or more, the factor agrees to pay you for the invoice and then they collect on the debt. Some factors will pay you the majority of the receivable and complete the payment once the debt is collected while others will pay only a small portion until final collection is made.
The two biggest benefits of factoring for small carriers and owner-operators is that they spend less time chasing past due receivables and more time driving, and a steady stream of revenue coming into the business. There is a cost to that, of course in the form of the fee, but knowing you have income coming in on a regular basis can lift a great weight off your back.
If you think factoring is for you, there are plenty of businesses that work with trucking companies specifically, including Triumph Business Capital, which offers TriumphPay.
Signing on with a factor will require a number of steps, including, oftentimes, setting up a separate bank account. It can also lead to problems if you are not fully aware of how factoring works. Here are some of the most common mistakes companies new to factoring make:
1. Failure to read and understand the fine print, including fees. The fine print trips up people all the time, including investment bankers and CEOs of large corporations. Don’t let it trip up you. The factor may tell you they will take a 5% factoring fee, which sounds good until you receive your first payment and see that there are several “hidden” fees you didn’t know about that have resulted in a 10% cut being taken. Ask questions and work with a factor that is upfront and transparent about all fees.
2. Failure to have payment sent to the factoring company. This is actually a common problem that trucking companies new to factoring run into. Once you factor an account receivable, the shipper should send the payment to the factoring company. Sometimes, the shipper will send the payment to you unknowingly. That is no longer your money – the factor has already paid you to buy the invoice – and you need to contact the shipper and the factoring company to ensure payment is properly sent.
3. Failure to properly vet the factoring company. As mentioned earlier, factoring fees can range from a few percentage points to 10% or even 20% of the receivable. What fee you get charged will depend on a number of factors, but you can help yourself by vetting the factoring company yourself. What is its reputation? How quickly does it pay? Can you get in touch with someone if there is a problem? Do a web search for information on the company and check with the Better Business Bureau. Just as importantly, is the factoring company funded? You won’t get paid if the factor doesn’t have sufficient financial resources. Triumph suggests checking with the International Factoring Association, which has a code of ethics that all factors are expected to follow.
4. Relying on factoring as the only means of revenue for your business. This is a tricky one, as one of the reasons many small truckers turn to factors is that it is easier to manage their cash flow. However, using a factor as the only way to fund your business is not always the right strategy. Factoring can be part of the solution, but it shouldn’t be the entire solution. For longer-term needs, small business loans and other financing tools are available and can sometimes be a better avenue, depending on your needs. Some factoring companies are also financially backed by banks and can provide a one-stop shop for your needs. In some cases, they may be the better option as they can recommend the best funding approach for you.
5. Choosing the wrong kind of factoring. Generally, there are two kinds of factoring available, recourse and non-recourse. If you don’t understand the difference between the two, then your business could be at risk. Recourse factoring leaves the responsibility for the account receivable in the hands of the trucking company. If the factor is unable to collect on the debt, then the trucking company is responsible for repaying the factor any money previously advanced under the factoring agreement. Non-recourse factoring is exactly the opposite. The factor takes on all the responsibility and if it is unable to collect the debt, it becomes lost revenue for the factor. However, non-recourse factoring usually includes higher fees, so you need to weigh your options.
6. Working with the wrong customers. One of the benefits of factoring is that it eliminates the time a company owner spends chasing bad debts. However, if you are chasing bad debts, chances are the factor would have to as well. The difference is that the factor will not continue this practice. Most factors will run a credit check on your customer before agreeing to factor that account receivable. If the factor rejects that receivable, it is a huge red flag that the shipper is not likely to pay their debts and you should probably reconsider your relationship with that shipper.
7. When quoting rates, know beforehand if you are going to factor that accounts receivable. If you are quoting a rate of $2,000 for a load, which will be factored by 5%, your share of the payment from that load will only be $1,900. If that is an acceptable rate for you, that’s fine, but you should consider that factoring fee when building your rate quotes.
Factoring can be a great solution for carriers, especially smaller carriers and owner-operators that may need some assistance in collecting debts and generating a successful cash flow strategy, however, there are many pitfalls that can occur along the way. To avoid these, it’s important to understand what factoring is and what it is not, asking questions, and reading the fine print so you don’t get caught unaware.