What Is Freight Factoring? A Dead Simple Introduction

April 15, 2020

What Is Freight Factoring? A Dead Simple Introduction

In the trucking industry, slow payments are a reality that all companies have to contend with. Trucking companies typically have to wait weeks or even months at a time for slow-paying customers to send in checks to cover their freight bills.

This is the way it’s always been. Even today, with the industry going through digital transformation, many companies are still using paper payment systems, which tend to be very inefficient.

Unfortunately, this system puts trucking companies at a major disadvantage. Shipping freight is highly resource intensive. There are many expenses to factor in, including repairs, payroll, and fuel.

Without steady cash flow, it’s impossible to keep operations running at an optimal level. This can force a company to spiral into debt—and potentially even bankruptcy.

How do companies circumvent this problem and keep fleets moving? Trucking companies typically use a financial strategy called freight factoring.

What Is Freight Factoring?

Freight factoring is a type of financial transaction where a shipping company sells its invoices to a third party at a reduced rate in exchange for immediate cash.

By using freight factoring, trucking companies can receive immediate capital to pay for essential shipping services without having to take out traditional loans or liquidate their assets. Freight factoring is now a widely practiced financial strategy in the trucking industry.

There are two types of freight factoring that companies can use.

1. Recourse Factoring

In a recourse factoring agreement, the trucking company takes full responsibility for the invoice. In other words, if the customer fails to pay, then the trucking company is legally liable.

As a result, recourse factoring typically costs less. However, it’s a risky option and should be used only when dealing with customers that have a proven track record of success.

2. Non-Recourse Factoring

In a non-recourse factoring agreement, a third party will purchase an invoice outright, assuming full responsibility for payment.

Non-recourse agreements cost more, but they’re less risky for the trucking company. They’re better suited for dealing with new customers or organizations with a poor financial track record.

Benefits of Freight Factoring

It’s easy to see why trucking companies choose to use freight factoring, especially considering the immediate assistance and stability that it provides.

For example, companies often use freight factoring to pursue new shipping deals and make operational improvement to their rigs. These investments would be difficult or otherwise impossible to make without spare capital.

Freight factoring can also offer the following benefits:

Supply Chain Enablement

The world runs on supply chains. When supply chains break down, commerce stops, leading to serious economic fallout.

As such, shipping companies have a responsibility to keep operations going—no matter the cost. Freight factoring makes this possible, allowing businesses to keep going even when they lack immediate funding.

Driver Compensation

Drivers need to be compensated quickly and fairly. When truckers don’t get paid, they are quick to file union grievances. This can lead to a host of negative consequences, including strikes and penalties.

By using freight factoring, companies can pay drivers faster, avoiding messy legal issues and reducing turnover.

Stronger Operational Performance

Steady capital is necessary to keep a fleet running smoothly.

Freight compensation can help companies make timely repairs, thereby avoiding potential issues resulting from delayed maintenance checks. In turn, this can improve the lifespan of vehicles.

What about the drawbacks associated with this practice?

Risks of Freight Factoring

While freight factoring offers several advantages, it’s not always an ideal solution for the trucking industry.

Freight factoring is ultimately a stopgap—a mechanism that companies can use to stave off financial trouble and keep operations running, often to their own detriment.

Here are some of the common risks associated with freight factoring.

Dependence on Freight Factoring

Any sound businessperson will cringe at the words “quick cash.” Even when you get a good rate, you’re still making another company rich at your own expense.

When you sell an invoice at a reduced rate, you bet against your own company—and ultimately, you lose money every time.

Customer Service Issues

Customers—even slow-paying ones—are the lifeblood of any shipping company. As such, they need to be respected and taken care of, or they will be quick to seek out the services of competitors.

Engaging in recourse freight factoring is like washing your hands from the customer. It’s selling their debt to another organization, removing your company from the transaction, and exposing them to any number of additional third-party creditors and sharks. This can irritate customers, potentially damaging your relationships.

Deeper Debt

Companies are often quick to make non-recourse deals to secure better rates—especially when dealing with customers that they know and trust. This can lead to trouble, though.

For example, a customer may be acquired or claim bankruptcy with minimal notice. This may result in a freeze on their assets and delaying payment indefinitely—putting the shipping company on the hook to collect payment. This can create deeper debt for the company.

High Fees

Companies that don’t have stellar credit histories often wind up getting hurt by freight factoring. Factoring companies usually conduct credit checks on their customers, and they tend to ask for higher fees from companies that have a bad rating.

On top of that, accepting freight factoring can further worsen bad credit when it’s not managed properly. It’s a slippery slope that your organization should avoid if at all possible.

How to Avoid Relying on Freight Factoring

As you can see, freight factoring is one solution that trucking companies can use to maintain cash flow. But it’s not the only option.

A growing number of companies are starting to use mobile solutions to process payments immediately at the time of delivery—saving time and avoiding back-end complications.

For example, Vector offers a mobile billing solution that drivers and telematics providers can use to seamlessly collect money from customers.

The way it works is simple: At the time of delivery, all the driver or telematics representative has to do is open the Vector mobile app and scan the proof of delivery and any other supporting documents. The mobile app will record the documents and automatically send an invoice to a transportation management system (TMS).

By using this app, companies can eliminate or reduce paper transactions. They can process payments immediately, without having to go through any third-party credit agencies.

As such, the Vector mobile app can eliminate headaches that come from having to chase down debt.

A Better Way to Deal With Customers

Vector is also a much better way to deal with customers. Shipping teams can simply request an easy mobile transaction from customers instead of selling their debt to third-party agencies.

What’s more, Vector is a great solution for businesses that have only one or two shipping customers and can’t easily secure freight factoring agreements.

In other words, creditors typically assess a trucking company’s customer diversity before making an offer. This way, they can ensure the company won’t go under before paying their debt. Creditors often deny small trucking companies or give them poor rates.

So, by using Vector, small organizations can have an easier time collecting payments in a way that is fair, easy, and cost effective.

The key takeaway here is that the trucking industry needs to evolve beyond freight factoring.

If more companies start to use mobile payment solutions, they will reduce their dependence on creditors—leading to an industry that is more stable and efficient.

This post was written by Justin Reynolds. Justin is a freelance writer who enjoys telling stories about how technology, science, and creativity can help workers be more productive. In his spare time, he likes seeing or playing live music, hiking, and traveling.

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