Carriers have a very challenging job. Beyond the rigors of the road, freight companies are constantly working to properly manage their cashflow so they can have enough money on hand to meet their own debt obligations and also pay for expensive repairs and ongoing maintenance.
Sometimes, carriers can find themselves in a challenging financial position, where they need cash quickly or need to improve their overall cashflow. One of the most common ways these companies can solve that issue is through what’s known as factoring.
Through this arrangement, your company will sell its outstanding invoices to a service known as a factoring company. This company will then pay you for these invoices upfront.
In essence, the factor will be providing you with a short-term secured loan, since the outstanding invoices will serve as the collateral. In return, the factor will charge fees and will handle the collection aspect for you.
Below is a more detailed description of some of the fees and conditions to look out for in a factoring agreement, as well as mistakes that trucking companies need to avoid with factoring agreements.
Fees to look for in a factoring agreement
Every factoring agreement will detail all the fees that are being charged per the contract. Sometimes, these fees will be buried in the fine print of the contract. Here are some of the main fees you should look out for.
Some factoring agreements have a set period of time they last for. If you end the relationship before the end of this agreed-upon date, you may have to pay what’s known as a termination fee. Ideally, you will enter into a factoring agreement that doesn’t have these fees or that has low termination fees.
There may be an ongoing fee that the factor charges for carriers that use their service. There are various ways the factor could base this fee, either as a flat amount, a percentage of the total invoices you sell to them or a minimum amount based on how much you use their service.
Origination / Draw Fees
Most factors will charge an upfront fee at the start of new agreements. In traditional loans, this is known as an origination fee. It’s either a flat fee or a percentage of the first group of invoices you submit to them.
Credit Protection Fees
If your customers don’t have great personal and/or business credit, the factor may charge what’s known as credit protection fees. This will essentially protect them in case they are unable to collect on the outstanding invoices you sell to them.
Other Factor Terms to Consider
In addition to the fees, there are other common terms that will appear on factoring agreements. It’s important that you familiarize yourself with what they are, how they work and how they apply in your particular agreement before signing on the dotted line.
Here are three of these common terms.
Invoicing and assignment schedules
Most factoring services will require you to notify your customers that you have sold your invoices to them, and that they will be the ones who will collect on the outstanding payments due.
The agreement will outline how you must do this. Typically speaking, you’ll add a note on your invoices that all payments need to be made directly to the factoring company and not to you.
The agreement language will also state that if one of your customers sends payment to you by mistake, you are required to turn that payment over to the factoring company.
Some factors will also require you to send a full list of all invoices and accounts that you have sent to them as part of the agreement. This will keep both sides of the agreement on the same page at all times.
The big benefit to working with a factoring company is that you will get advanced payment for a portion of your outstanding invoices. As per the agreement, the factor will then take out whatever fees they are charging you for the service and keep the remainder of the invoices in an escrow account.
This remainder is what is known as the reserves. In most cases, the factor will hold the reserves in an escrow account until your customer pays the full amount of the invoice.
The agreement will then state how long the reserves will be held in escrow before being released to you. The timeframe could vary from one factor to the next, but it’s typically a few days or a few weeks.
Representations and warranties
The representations and warranties section of the factoring agreement is similar to language in many other contracts. This section will outline all the things that your company is agreeing to as part of the contract, which includes that your company is solvent and isn’t breaking any laws.
Most factoring agreements will also lay out that all invoices that you sell to the factor are indeed real and you have a legal right to sell them to the factor.
The language in the contract will likely stipulate that if you don’t hold up your end of the bargain, in essence, the company could either chose to deny you payment or take some legal action against your business.
6 factoring agreement mistakes every trucking company should avoid
Invoice factoring can be very beneficial to trucking companies in Gainesville, Georgia as well as everywhere else. But, they can also be detrimental, too, if you make some common mistakes. Here are six mistakes every trucking company needs to avoid in factoring agreements.
Not reading the contract: Don’t forget to read the fine print.
Not knowing what’s required of you: You don’t want to misunderstand your obligations.
Tying yourself up: It’s best to enter into shorter-term agreements to keep your options open.
Not sending invoices: Factors need invoices to prove you have completed the job. Make sure to send them and not a purchase order.
Not understanding the type of factoring: With spot factoring, you can choose which invoices you want to factor. With contract factoring, you must submit all your invoices to the factor.
Not getting the best deal possible: You should see if non-recourse factoring is an option. This would mean the factor would take the hit if they can’t collect on an invoice, rather than selling it back to you.