Freight factoring is a financial service that’s become crucial to the trucking and logistics industry, especially for smaller fleets and owner-operators.
Freight factoring allows trucking companies to get paid for completed deliveries by converting their unpaid invoices into immediate cash. Instead of waiting for customers to pay, you can receive 95% or more of your invoice value upfront.
This article will help you understand what freight factoring is, how it works, and how to find a high quality freight factoring company so you can get paid faster.
Understanding Freight Factoring
Freight factoring, also known as invoice factoring, is a financial transaction where trucking companies sell some or all of their invoices to a third-party factoring company, in exchange for immediate cash.
In logistics, freight factoring plays a key role in helping with cash flow management. This is particularly important because carriers often deal with extended payment terms ranging from 30 to 90 days. By providing quick access to funds, freight factoring allows trucking businesses to cover operational costs and invest in growth.
Unlike traditional loans that require collateral and incur debt, freight factoring involves selling future receivables so it doesn’t affect your company’s balance sheet.
Key Components of Freight Factoring
The three main participants in freight factoring are the factoring company, the carrier, and brokers or shippers.
Factoring Company
A factoring company is a financial institution that purchases invoices from carriers. They provide an immediate cash advance on invoices, bridging the gap between delivery of a load and payment from shippers.
When selecting a factoring partner, it’s important to look at their experience with trucking, fees, contract terms, and customer service. While there are good freight factoring companies, there are also bad factoring companies you need to steer clear of.
Carrier / Trucking Company
Trucking companies often face cash flow challenges due to delayed payments. Using freight factoring, they can improve cash flow rather than worrying about collections and waiting for payment.
Brokers / Shippers
Brokers and shippers are responsible for paying freight charges to carriers. Payment terms range from 30 to 90 days, so carriers may need to wait months to get paid for work they’ve completed.
How Freight Factoring Works
Freight factoring is a straightforward process to improve cash flow for trucking companies. Here’s a step-by-step overview:
1. Proof of Delivery
Once a carrier gets proof of delivery, they generate an invoice for the load and submit it to the shipper or broker.
2. Submit Invoices
Instead of waiting weeks or months for the shipper or broker to pay, the carrier submits this invoice to a freight factoring company for processing.
3. Approval Process
The factoring company verifies the legitimacy of the invoice and conducts a credit check on the shipper or broker. This step ensures that the invoiced party has a strong likelihood of paying their bill.
4. Advance Payment
After approval, the factoring company advances a significant percentage of the invoice value, usually between 95% to 97%, often the same day, providing the carrier with cash to maintain operations.
5. Collecting Payment
The factoring company assumes responsibility for collecting payment from the shipper or broker once the invoice reaches its due date.
Factoring companies have highly trained professional teams that manage the entire collections process for you, which is a side benefit of factoring that’s often overlooked.
6. Final Settlement
Once full payment is received from the broker or shipper, the factoring company releases any remaining payment to the carrier after deducting their fee, which typically ranges from 1% to 5% of the invoice value.
An invoice factoring calculator can help you see how the fees will impact your bottom line.
Types of Freight Factoring
We’ll run through the main types of freight factoring carriers can choose based on their financial goals and risk tolerance. These arrangements offer different terms and levels of protection, allowing trucking companies to set up a factoring solution that matches their needs.
Recourse vs Non-Recourse Factoring
Recourse Factoring
In recourse factoring, the carrier assumes the risk of non-payment by the broker or shipper. If an invoice remains unpaid past its due date, the carrier must reimburse the factoring company or replace it with another invoice.
Pros: Recourse factoring generally offers lower fees since the carrier retains some liability for payment issues.
Cons: The carrier faces financial risk if the broker or shipper defaults on payment.
Non-Recourse Factoring
With non-recourse factoring, the factoring company absorbs the risk of non-payment, meaning they cannot demand repayment if a broker or shipper fails to pay.
Pros: Non-recourse freight factoring provides peace of mind by protecting carriers from financial loss if a customer doesn’t pay.
Cons: Slightly higher fees because of the increased risk taken on by the factoring company.
Spot Factoring vs Contract Services
Spot Factoring
Spot or selective factoring allows carriers to choose specific invoices to factor rather than committing to factoring all invoices. Ideal for carriers who require occasional cash flow assistance without being locked into long-term contracts.
Pros: Flexibility in financing and no need to factor consistently.
Cons: May come with higher fees compared to longer-term agreements.
Contract Factoring
In this arrangement, carriers enter into ongoing agreements with a factoring company, often encompassing most or all invoices over a set period. Ideal for carriers seeking consistent cash flow management.
Pros: Lower fees due to established contract terms.
Cons: Less flexibility for carriers.
Benefits of Freight Factoring
Freight factoring offers a number of advantages to carriers:
1. Improved Cash Flow
The most obvious benefit of freight factoring is the immediate improvement in cash flow.
By converting unpaid invoices into cash for a relatively low cost, carriers can use the money to pay drivers and mechanics or buy fuel for the next load.
2. Offload Collections
Factoring companies handle payment collections, allowing carriers to focus on their core operations like driving, dispatching, fleet management, and customer service instead of dedicating time and resources to chasing payments.
3. Reduce Credit Risk
By verifying the creditworthiness of shippers and brokers before purchasing invoices, factoring companies reduce the risk of dealing with insolvent partners. Freight factoring companies, like OTR Solutions, offer unlimited free credit checks.
Potential Drawbacks and Risks
While freight factoring provides many benefits, you need to consider potential drawbacks and risks to ensure it aligns with your business needs. Not all carriers benefit equally from factoring. To determine if factoring is right for your business, it’s best to talk with a financial advisor.
Cost of Factoring
Factoring usually costs 1% to 5% of the invoice value. Known as the discount rate, these fees can add up over time, affecting profitability.
Hidden Fees
Before signing any contract, it’s vitally important to review contract terms and conditions to avoid hidden fees or obligations. Knowing what’s included in your agreement can help you avoid the negative impact caused by unexpected charges.
Blanket UCC Filings / Liens
Watch out for blanket UCC (Uniform Commercial Code) filings, which some factoring companies use to secure their interest in your accounts receivable. A blanket UCC filing can create potential complications by covering all of your business assets, making it challenging to obtain other forms of credit or switch factoring companies.
Good factoring companies only place UCC filings on the specific invoices you’ve factored.
Alternative Options
Large fleets have more negotiating power and financial strategies in place, allowing them to maintain cash flow without needing to factor invoices. Once a company reaches a large enough size, they normally switch to lines of credit or other types of alternative financing that reduce the need for factoring.
Choosing a Freight Factoring Partner
Choosing the right freight factoring partner is crucial. With over 50 factoring companies in the U.S. offering services for trucking, making the right choice can be overwhelming.
To simplify the decision-making process, it’s important to focus on several aspects crucial to selecting a long-term partner.
1. Freight Factoring Rates
While freight factoring rates vary, a good factoring company will consider your revenue, invoice value, and customer risk. Rates are important, but shouldn’t be the only deciding factor. Customer service and reputation tend to matter more in the long run.
2. Best Trucking Factoring Companies
Consider top-rated factoring companies for trucking that stood out during our interviews and research.
OTR Solutions: Known for their exemplary customer service and seamless integration with DAT.
Riviera Finance: Offers friendly customer service and transparent contracts with non-recourse options.
Single Point Capital: Family-owned with strong customer feedback and no hidden fees.
3. Key Considerations
When selecting a factoring provider, focus on:
- Contract terms: Fees, rate structures, revenue requirements, and potential personal guarantees.
- UCC Filings: Understand when they file what they cover, ensuring they don’t do blanket liens.
- Customer Service: Evaluate customer support; ensure your account manager understands your business.
4. Is Freight Factoring Right for Your Company?
Factoring might be beneficial if your company is new or growing quickly with limited access to traditional financing or requires rapid cash due to extended payment terms from clients.
Steer clear of freight factoring if your margins can’t cover the fees, if your clients usually pay quickly, or if you have other more affordable financing options.
End of the Road for Freight Factoring
Freight factoring is a financial solution that offers immediate cash to trucking and logistics companies by converting outstanding invoices into readily available funds. This helps businesses maintain operations, manage expenses, and invest in growth without taking on debt. Factoring companies also handle collections, allowing companies to focus more on core operations rather than financial management.
However, it’s essential for businesses to carefully consider the terms and conditions of a factoring agreement as fees can vary significantly among providers. Thorough research and understanding of the contract specifics are crucial to ensure compatibility with business needs and operations. Ultimately, for trucking companies facing cash flow challenges or looking to streamline their accounts receivable process, freight factoring is often the best solution.
