Factoring basics

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KeyFactor

Active Member
May 3, 2011
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I know lots of people have negative experience with factoring and that there are lots of misconceptions about it, so I'd like to address some FAQs I've seen in this forum. Full disclosure - I am in the factoring business:
  • what is factoring? Its the sale of your invoices to another company (the factor) in exchange for immediate access to some percentage of those invoices. In some cases, you are charged a fixed rate, say 5%, and receive 95% immediately. In other cases, your rate depends on the number of days to pay the invoice, so you might get, say 90% immediately and the balance later after deduction of applicable fees. Generally, the second approach is cheaper.
  • why do I need to factor? Improved cash flow. It's the lifeblood of your business (and NOT the same as profit). If factoring helps you improve your cash flow and reduce your risk at rates that make sense, you should consider it. The following point cannot be over-emphasized: if your business is not growing at a rate that justifies the factoring costs, you should not be factoring. I agree that quick-pay is a valid option, but not all brokers offer it, so factoring may be considered in those cases. Many in this forum associate factoring with failing businesses - nothing could be further from the truth. Factoring is a form of financial leverage, it will allow a well-run business to magnify its success, but will also serve to magnify the deficiencies of a poorly run business. A good factor will be close enough to its client to monitor their financial progress and seek to continuously improve it. A bad factor will sit back and not ask questions and allow their client to fail. We do not win anything by allowing our clients to drive themselves into the ground.
  • what are the other alternatives to factoring? Since most businesses are required to spend money in order to generate a profit, they inherently experience negative cash flow before it swings back the other way on payment of their invoice. Mature companies can finance the initial outflow with existing cash reserves, or bank facilities. Emerging or growing companies are rarely approved for bank facilities and don't have much cash, so many turn to factoring as a means to achieve the same outcome, but the two are not the same. Factoring is more expensive than a typical operating line from a bank, but the bank will not manage your receivables or analyze the credit of a customer BEFORE you accept a load. A bank will not review your financials and make sure their solution still makes sense for you. A bank will not answer the phone after 5pm to answer your questions and will sometimes make you wait for days before answering at all. We all love banks for their low rates, but they are large, rigid institutions that provide little in the way of service to entrepreneurs. Banks are not your partner, but a good, reputable factor is.
  • what are the downsides of factoring? Many on this site will tell you it is too expensive or that many factors are not reputable. Some factors do not report credit accurately, some are unprofessional to their clients and customers of clients alike, some are unresponsive and the list goes on. Many of these criticisms apply to carriers, brokers and other industries, so they're not specific to factoring. Do your homework and find a good, reputable factor.
Bottom line: factoring is not for everyone, but it can help good companies grow if used properly, so do your homework and choose wisely.
 
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I work for a factoring company, and agree with both posts below. Most factors are good companies but if you can self-finance your business with cash, and you are ok spending time to managing your invoices and collections, then you probably don't need to factor.

If you do choose to factor I would recommend the following that could save you $1000's of dollars:

1. View factoring as "interim" financing: Don't plan on using it forever. You should have an 'exit plan' to stop factoring, perhaps 12-24 months down the road, and move into self-financing your business. Also clearly understand the cancellation clauses in your contract. Many factoring companies require 60 to 90 days written notice to cancel otherwise you are automatically renewed for another year.

2. The cheapest quote is not always the cheapest cost: While you should talk to several factoring companies, if pick a factor based only on the lowest quoted price, you will probably pay for it in the long run. Why? Call it the "Big Box Store effect". You may get the cheapest price at Big Box Store, but what kind of quality are you likely to get? The same principle holds with just about any service, including factoring. "You get what you pay for". Remember the factoring company is represents you with your clients. If they are aggressive or disrespectful to your clients how likely are you to get repeat business from them?

3. Beware extra fees like "charge-backs": This is another way that a cheap quote can become very expensive. Factoring agreements, like any financing agreements, can be very complex. Get you factoring company to explain all fees BEFORE you sign the contract. The fine print of contracts will occasionally have additional 'administrative' or 'maintenance' fees. There can also be fees if you have a slow month, and don't hit prescribed minimum volumes. I have seen may clients who sign up for what they think is a 1.5-2% fee, actually pay 4-6% by the time all fees are accounted for. One big cost can be "charge-backs". A charge back is when an invoice (that you have received a cash advance on) becomes delinquent, that is your client takes more than 60-90 days to pay. Most factoring companies are "Full Recourse", that is they will can the old invoices 'bad debt', and require you to repay the money PLUS fees, that you were advanced 60 or 90 days earlier, or replace this invoice with another invoice, with the original fees added on top. Either way it can mess up your cash flow, and hugely increase the fees that you pay.

4. Non-Recourse Factoring = Peace of Mind: I'm biased because I work for one of the only Non-Recourse Factors out there, but if you have decided to factor this is the most important recommendation. Non-recourse factoring credit guarantees your invoices against bad debts and expensive "charge back" fees. The following example underscores the difference between full recourse vs non recourse factoring:

If you have a single truck that is factoring $10,000 per month at a 3% fee receiving a 95% advance, your monthly fees would be $300 per month or $3600 per year. With non-recourse factoring you keep the 95% advance regardless of whether your client pays. Let's suppose you have 1 $3500 load in a year not pay, because the shipper goes out of business or disappears. With non-recourse factoring you receive a $3325 advance (95%) which you keep. But if you use a 'full recourse' factor (or don't factor) you lose the entire $3500 (plus your time and effort in trying to collect on the invoice). Ironically the $3500 loss is almost the annual costs of non-recourse factoring ($3600 per year).​

Hopefully this helps you to make more informed decisions. Drive Safe.


Gord Onley
JD Factors
 
We deal with many factoring companies each day. Most are decent people to deal with. Which one do you work with Gord? Our concern often is if we are paying the end carrier. How can you guarantee your client is the end carrier? And that we will not see another invoice from a different carrier later?
 
[QUOTE="
4. Non-Recourse Factoring = Peace of Mind: I'm biased because I work for one of the only Non-Recourse Factors out there, but if you have decided to factor this is the most important recommendation. Non-recourse factoring credit guarantees your invoices against bad debts and expensive "charge back" fees. The following example underscores the difference between full recourse vs non recourse factoring:

If you have a single truck that is factoring $10,000 per month at a 3% fee receiving a 95% advance, your monthly fees would be $300 per month or $3600 per year. With non-recourse factoring you keep the 95% advance regardless of whether your client pays. Let's suppose you have 1 $3500 load in a year not pay, because the shipper goes out of business or disappears. With non-recourse factoring you receive a $3325 advance (95%) which you keep. But if you use a 'full recourse' factor (or don't factor) you lose the entire $3500 (plus your time and effort in trying to collect on the invoice). Ironically the $3500 loss is almost the annual costs of non-recourse factoring ($3600 per year).​
[/QUOTE]

True dat, Gordo.

Non-recourse factoring is definitely something to consider and we offer a credit insured product too. It protects clients in the event of customer bankruptcy or undisputed non-payment; it does not protect against disputes, though, so if yours does, it's definitely worth mentioning here.

Using Gord's numbers, if the additional liquidity provided by factoring allows the client to add a second and third truck, and gross margins are 20% before factoring costs (17% after factoring costs), their gross profit goes from $700 to $1,130 to $1,785. Just as importantly, the factor also takes responsibility of several administrative tasks (credit analysis of customers, management of receivables) and allows the client to focus on acquiring new customers, which adds the most value to any business. Numbers aside, factoring helps the client sleep easier because he gets access to immediate cash to pay for fuel, plates, insurance and all the other things needed to be in the transport business.

htcollections, if the carrier submits a bill of lading and load confirmation that shows it was the carrier of record for the load, we accept that they in fact delivered the load. I often see a BoL with the broker's name on it, but the load confirmation shows the broker gave it to a carrier. In that event, I'm guessing the shipper would still be on the hook if they paid the broker but the carrier was not paid. Do you have any experience on this situation?

This discussion may seem self-serving, but if you read the posts in this forum on factoring, it's clear that people really don't understand the merits of factoring.
 
htcollections: I work for JD Factors. In regards to brokered loads, we pay the broker's carrier(s) directly, and the broker keeps the remainder. Because we are non-recourse the broker is assured that he will always keep his carriers happy in the event that a shipper doesn't pay.

KeyFactor's comments are bang on - As a transport company if you are ok with lowering your gross margin by say 3%, recognizing that with that you are covering the costs of managing your invoices and collections, and getting credit-protection (if you are with a Non-Recourse factor), then factoring will work for you and give you piece of mind. I can't imagine what it must feel like driving a $3500 load across the country, and the entire time thinking to yourself: "I hope I get paid for this".

2 additional thoughts:

  1. Advance Rate: Remember the advance rate is very important in calculating your cost. A 75% advance with a 2.5% fee is actually more expensive than a 95% advance at 3%.
  2. Selling all Invoices?: Some factors require you to sell them all invoices. To me this doesn't make sense, and JD Factors doesn't require it. After all if you have a long-term client who pays you promptly or offers you good quick-pay terms then you should be able to continue those relationships. In my opinion having to sell all invoices is greedy and unnecessary.
Drive safe everybody,
Gord
 
I have done business with JD Factors. They are professional and always polite! Keep up the good work! Glad to have you as a member!
 
I have recommenced JD Factors in past for some owner operators. and will continue when i hear of someone.
 
There are many good factoring companies. Make sure you understand the fine print before signing the contract. Do your research and see who offers you the best rates, etc.
 
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Ah...you raise an important point. Rates!

Excuse my rant, but I believe many people focus so much on rate, they lose sight of the bigger picture. Service! Like all of you, factors must be competitive with their rates, but if your customer asked any of you if you were the cheapest in town, I suspect most of you would find this focus to be short-sighted because it completely ignores the importance of things like responsiveness, reliability, timeliness, professionalism, safety and the ability to deal with the unforeseen. If you do your homework and know who provides good service at a competitive rate, you will make a good choice. You should ask the factor why they feel they offer the best possible service and make them convince you that they're right. What makes them different from other factors? It's about more than just the rate.

I find that many newer carriers know a great deal about trucking, but not about running a business. They are not financially literate so they rely completely on their accountants (some of whom are absolutely terrible) without taking the time to analyze and understand their results. They don't understand the nuances of contracts. They don't understand credit. That's where a good factor comes in. The factor should be your business coach and your partner. You should be able to reach them morning, noon and night to talk about urgent issues. THAT, I believe, is our true value proposition. Transport is such a competitive industry that you simply won't survive unless you run a tight ship.

Ok (deep breath), I'm done now and feel much better.
 
You raise a very important point keyfactor. Our industry is filled with excellent operators, knowledgeable of every aspect of transportation with years of on-the-road experience, yet lacking in basic business acumen. Transportation is not alone in this, you can see it in virtually every industry. A great window washer does not necessarily translate into someone that can run a great window washing business. I have no argument with a company who wishes to factor all or some of their invoices, but shouldn't the goal of any company be to "out grow" the need for a factor eventually, and be self financed? It just seems to me, that factoring ones invoices should be a short term, or temporary measure, employed until the company has the financial resources to stand on their own.
 
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No question about it, Loaders, you should only be factoring as long as your top line is growing at a rate that justifies the associated costs and as long as it is the best solution for your needs. The goal is for you to "graduate" to a senior lender or to be self-financed. If your factor is not advising you of this, then they are probably more interested in their own success than yours. We have clients that are bankable, but choose to stay with us because they don't like dealing with banks, because they appreciate the value of our other services (credit analysis, management of AR, credit insurance, etc.). They should convince you that your interests come first.
 
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