Understanding Factoring for Accounts Receivables - OTR Solutions

Understanding Factoring for Accounts Receivables

Understanding Factoring for Accounts Receivables

(Roswell, GA., June 20, 2022) – If your trucking company is like many small businesses, you are likely operating with a limited and delayed cash flow. The ability to keep running load-to-load may be difficult when you’re always waiting to be paid for your completed work. Most brokers and shippers pay in standard pay terms of 30, 60, or 90 days after invoicing, with the most common being net 30 from the day they’re invoiced, which can tie up valuable funds for a long time. Factoring can cut this timeline to getting paid shortly after delivery or within 24 hours, allowing you to get paid and move on to your next haul while staying cash positive. Here is what you should know.

What Is Factoring for Accounts Receivables?

Factoring is the process of selling your invoices to a factoring company for a small fee. The factoring company pays you within 24 hours and then collects the funds from the customer on their standard pay terms. Factoring for freight brokerage companies is also very common. The factoring company will handle the paying of your carriers.

As a trucking company, you’ll continue to work with your customer, usually a broker or shipper, as normal. After delivery, you will submit an invoice along with the proof of delivery and rate confirmation directly to the factoring company, usually via an online portal or mobile app. Upon receipt, the factoring company purchases the submitted invoice and transfers payment to your business account either the same day or the following morning. Once payment is received, your work is done, and the factoring company is responsible for invoicing and collecting payment from your customer.

Note that you must meet two basic requirements to use factoring. First, your company must be free of accounts receivable asset-related liens or any other legal encumbrances. Second, it is to your benefit to know your customers’ credit ratings, as this will help determine whether your invoices can be purchased.

What Are the Benefits of Factoring?

Factoring offers many benefits for small businesses. These include:

    • Use your invoices as collateral. Most business loans require you to put up significant assets as collateral. With factoring, all you need for collateral is the invoice. This means that you’re not risking your trucks or other assets if you run into problems.
    • Offer credit while reducing risk. Although factoring is only available to brokers and shippers with good credit histories, there is always a risk when payment is not rendered until after services are completed. Factoring reduces this risk by getting you paid immediately and shifting the burden of payment to the Factor
    • Get paid fast. Your money will no longer be tied up for months after load completion. You’ll get paid within 24 hours, freeing up that money to reinvest in the next haul.
    • Reduce your paperwork and headaches. You won’t need to worry about sending out payment reminders and chasing down slow payers. Just submit your invoice to the factoring company and move on.
    • Keep your trucks and drivers earning. Trucking companies only make money when the trucks are rolling. But if you’re waiting for payment, you may not have the cash to finance your next trip. Factoring keeps the cash flowing and the trucks on the road.
    • Scale your business. As long as the broker or shipper is approved and has good credit, you can use factoring for as many customers as you want. This makes it particularly attractive for companies that are in an aggressive stage of growth. As you add customers, you can continue to get paid for every invoice within 24 hours.
    • Long-term growth. While some businesses use factoring when they start their business, or finance a period of rapid expansion, it typically works best as a driver for continuous, steady growth.
    • Easy to obtain. If you’ve ever gotten a traditional business loan, you are familiar with the mountain of documentation that is generally required. And very small businesses may be shut out of certain financing programs altogether. Since your invoice is your collateral, you don’t need to jump through a lot of hoops. And even the very smallest businesses are eligible, provided they are unencumbered legally.

 

How Does Factoring Work and What Are the Different Types?

It’s important to understand that factoring is not the single solution to all of your company’s financial concerns. You may still need a traditional loan to cover such upfront expenses as buying trucks or equipment. But it does solve the common cash flow problems that many small businesses face when customers take 30, 60, or even 90 days to pay.

There are multiple types of factoring available, each with its own unique pros and cons. It’s important to understand how they work, and what the differences are.

Non-recourse Factoring vs Recourse Factoring

The two main types of factoring are non-recourse factoring and recourse factoring, often referred to as fleet factoring. In recourse factoring, although you have sold the invoice to the factoring company, you remain ultimately liable for payment on that invoice. In non-recourse factoring, the factoring company assumes the responsibility for collecting payment indefinitely under certain circumstances. This is complicated, so let’s break it down.

Non-recourse Factoring

In non-recourse factoring, the factoring company assumes the risk of late payments or bad debt. You won’t have to buy back the invoice unless it becomes uncollectible for a reason that isn’t covered in your factoring agreement. This is the preferred option for most small to medium-sized operations, as well as new businesses, because of the additional value and support it provides.

Non-recourse factoring can be slightly more restrictive due to the factoring company only factoring invoices from approved customers. This restriction usually excludes new brokerages and others with poor credit, where the majority of customers are still approved to factor. In addition, there are a few times when the factoring company will not pay. These rare instances include:

      • Direct invoicing rather than invoicing through the factoring company
      • Disputed or freight claim invoices
      • Breach of contract
      • Any situation in which you are found to have contributed to the payment issue (i.e. late delivery, failure to tarp, missed drop, etc.)

Companies that benefit most from non-recourse factoring typically include:

      • Small or medium-sized businesses that lack the cash flow to buy back invoices
      • New companies that need to minimize risk
      • Sole proprietors who are not interested in pursuing collections on their accounts receivable and are looking for some protection against bad debts
      • Carriers that want to expedite their reliable cash flow

 

Recourse Factoring

You will submit the invoice as normal and receive your money within 24 hours. The factoring company will then make all reasonable attempts to collect payment from the broker or shipper.  But if the customer does not pay, usually defined, for example, by a 90-Day Purchase Period, you are obligated to buy back the invoice and take over the attempt to collect once the 90 days is up.

Recourse factoring programs are often accompanied by an additional reserve percentage held on each factored invoice. The reserve is not a fee, it simply provides a pool of funds the factor can use when a factored invoice surpasses the 90 Day Purchase Period. This way the carrier’s day-to-day funding isn’t directly affected when an invoice is charged back. If the invoice pays in the correct time period, the reserve amount held from initial funding (usually 2%-5% of each invoice) is released back to the carrier in full.

This type of factoring is designed for carriers who operate with enough customers, and produce enough volume, to spread the risk of non-payment across their business. This way, you won’t have to worry as much about the credit status and factoring approval of the customer or broker since you are agreeing to take on most of the risk.

Recourse factoring is generally best for companies that:

      • Have an operation large enough to offset the additional risk.
      • Want more flexibility with who they work with.
      • Have established teams and processes to account for potential collection responsibility.

 

Hybrid Factoring

Hybrid factoring defaults to the program type for which a particular customer can be approved. If the customer is credit-worthy enough for non-recourse factoring, the factoring company purchases the invoice under those terms. However, if the customer’s credit profile is less than ideal, the invoice can still be factored but it will be purchased under recourse factoring terms.

Hybrid factoring is particularly useful for companies that have both low-risk and higher-risk clients. You can use non-recourse factoring for those clients with strong credit profiles, and recourse factoring for those who are potentially less reliable.

Fuel Advances

Fuel advances aren’t a separate type of factoring, but rather an option offered to carriers by many factoring companies. In this program, you will be able to get an advance on your invoice (generally 40 to 50%) to pay for fuel. You simply pick up the load and submit a copy of your Bill of Lading and rate confirmation to the factoring company. The factoring company confirms your documentation and then pays the advance immediately to your fuel card.

Which Type of Factoring Is Right for Me?

Like most business decisions, this depends on many different factors. Each type of factoring has both advantages and disadvantages to consider. To help you decide, try asking yourself a few questions:

        • Is the customer creditworthy and reliable?
        • How much risk do I want to absorb?
        • How long do I have to buy back unpaid invoices?
        • What circumstances are covered by non-recourse factoring, and are they likely to happen?
        • Do I want to stick to one type of factoring, or would a hybrid approach work better for my customer list?

 

Why Use OTR Solutions for Factoring?

OTR Solutions provides industry-leading technology and financial services, tools, and support to help carriers and brokers start and grow a successful operation. Trucking companies and freight brokerages of all sizes turn to OTR to receive reliable financing and back-office solutions, a dedicated fuel team, up-to-date news and education, and technology and innovation to prepare them for anything and everything.

Learn what we can do for you today!