Maintaining a stable cash flow is critical to the success of your trucking business. Many clients settle their outstanding invoices in a timely manner, which allows you to keep the revenue flowing. However, if you have a string of clients who drag their feet when it comes time to pay, you may be feeling a financial strain. The good news is that you can stabilize your income by taking advantage of factoring contracts. Here is everything you need to know.
What are freight factoring contracts?
Also known as invoice factoring, freight factoring is the process of selling outstanding invoices to a third party. The buyer pays you the majority of the invoice’s total balance and then seeks payment from your client for the full amount.
Factoring contracts outline the terms of this exchange. Specifically, your contract will detail which invoices you factor and the rate the factoring company charges you.
While factoring rates vary, they typically range between 0.5% and 4% of the invoice’s total value. For instance, if you factor a $5,000 invoice, you would get paid between $4,975 (99.5%) and $4,800 (96%), depending on the partner company’s rate.
How do freight factoring contracts work?
Freight factoring contracts are straightforward and look something like this:
- You agree to haul freight for a customer
- You issue an invoice for your services
- After delivery, you sell the invoice to a factoring company, which pays you 90% or more of its value
- The factoring company now owns the rights to collect on the invoice
- It collects the invoice balance directly from your customer.
Here’s a simple example. Let’s say that you recently delivered a shipment and billed the client $5,000. However, this client is notorious for taking 60 to 90 days to pay invoices. Instead of waiting several months to get paid, you sell your invoice to a factoring company and receive payment for the balance, minus its fee.
Types of freight factoring agreements
Generally speaking, there are four types of factoring agreements.
Full-service factoring
Full-service factoring is what it sounds like. When you enter into this type of agreement, the factoring company will handle everything. This service includes processing invoices, disbursing payments to you and communicating with customers after services are rendered.
The downside of full-service factoring is that you may have to factor all of your invoices with the company.
Nonrecourse factoring
One of the biggest distinctions in factoring agreements is whether it is a nonrecourse or recourse contract. Under a recourse agreement, the factoring company can require you to refund the money it paid you if the customer defaults on the invoice.
But if you enter into a nonrecourse factoring contract, the factoring company cannot force you to reimburse it if the client refuses to settle the debt. Nonrecourse factoring companies typically charge a higher rate because they take on all the risk.
Spot factoring
Spot factoring contracts enable you to pick and choose which invoices to sell to the factoring company. Since the company will be buying a lower volume of invoices from you, it will likely charge a higher factoring rate.
Invoice discounting
Invoice discounting is similar to factoring, with one exception. When you engage in invoice discounting, you retain control over communications with the customer. This means that you pursue the payment and ensure it is remitted to the factoring company.
Factors to consider when choosing freight factoring providers
Before entering into an agreement with a factoring provider, we suggest that you consider the following characteristics.
Reputation in the industry
You can learn a lot about a factoring company by examining its reputation. What are others saying about the company on review forums? If most of the feedback is positive, it’s probably a good company to partner with.
Make sure to form your own opinions as well. If you are on the fence about a company, give it a call to further evaluate its services.
Customer service and support
Finding a partner that provides exceptional customer service and support is critical. Ideally, you want to work with a company that offers after-hours support, as you will likely be making some deliveries outside of banker’s hours.
When evaluating a company’s support capabilities, consider a few factors. Specifically, find out when live support is available. Also, ask how long it typically takes the company to process your invoices and disburse payment.
Terms and conditions of the contract
Before signing a contract, review all the terms and conditions. Some aspects that you should pay close attention to include:
- The factoring rate
- Which invoices you are required to factor
- Whether you can terminate the contract
If you have concerns, bring the contract to your attorney before signing it.
Transparency and clarity
Are the factoring company’s terms transparent and straightforward? If not, it may not be the right partner for your business.
Factoring shouldn’t be confusing. It is meant to be a mutually beneficial agreement that allows you to stabilize cash flow while the factoring company generates a profit for its services.
Do I need to work with an invoice factoring company?
Not necessarily. If your clients typically settle invoices in a timely manner and your cash flow is stable, your business might do just fine without factoring contracts.
But if payment delays are hindering your organizational growth, it’s a great idea to explore your options. Working with an invoice factoring company may be the missing link that enables you to build your business.
FAQ
Whether you can break a factoring contract depends on the terms of the agreement. Some agreements allow either party to terminate the contract at any time and for any reason, while others are more restrictive.
Factoring companies usually take 0.5% to 4% of your invoice. If an invoice is $5,000, you can expect to pay between $25 and $200. Nonrecourse agreements might charge a higher percentage, so keep this in mind when looking for a factoring company.
The factoring rate will vary depending on the terms of your agreement. However, you should expect to pay between 0.5% and 4% of each invoice when factoring.
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