Freight factoring explained: what you get, what it costs, how to book it

How freight factoring works

A shipper or broker usually pays a carrier on terms of 30 days or more after it receives the invoice. Meanwhile the carrier has already paid for fuel, the driver, insurance and the truck payment. Factoring closes that gap: you sell the invoice to a factoring company, the factor pays you most of its value within a day or two, and the factor collects from your customer when the invoice comes due.

Every factoring deal has three numbers in it:

• The advance: the share of the invoice the factor pays you when it buys the invoice. Freight factors commonly advance most of the invoice, and the exact rate is in your agreement.
• The reserve: the part of the invoice the factor does not advance. It holds this back as protection against short pays and disputes, then releases it when the customer pays in full.
• The fee: what the factor charges for the service, usually a percentage of the invoice. Some factors take it from the advance, others take it from the reserve when it is released, and some charge more the longer the customer takes to pay.

The three always add back to the invoice total. If they do not, something in the agreement or the statement needs a closer look.

In this illustration the carrier gives up 60.00 to be paid about a month sooner. Whether that is a good trade depends on what that month of cash is worth to your business, which is the question the last part of this article comes back to.

Recourse and non-recourse factoring

The most important clause in a factoring agreement is what happens when your customer does not pay.

With recourse factoring, the credit risk stays with you. If the customer has not paid by a set date, you buy the invoice back, usually by having the factor take the amount out of your reserve or your next advance. Recourse factoring generally costs less because the factor is mostly lending you money against invoices, not taking on bad debts.

With non-recourse factoring, the factor absorbs the loss if the customer cannot pay, but read the definition closely. Many agreements limit non-recourse protection to a customer’s insolvency, and still send the invoice back to you if the customer refuses to pay because of a dispute over the service, a damaged load, missing paperwork or a short pay. The factor also decides which customers it will accept on non-recourse terms.

If a factored invoice does come back to you and the customer never pays, the bad debt is yours for tax purposes too. In Canada, the Income Tax Act lets a business deduct debts it establishes have become bad in the year, and the Canada Revenue Agency has said that a supplier who takes back a receivable it had assigned on a recourse basis may claim the GST/HST bad debt deduction once it writes the debt off, provided the usual conditions are met. That CRA statement is an older policy paper that the CRA says may not reflect later law changes, so confirm the treatment with your accountant before you rely on it.

The notice of assignment: why your customer pays the factor

When you sign a factoring agreement, you assign your right to be paid on those invoices to the factor. To make that work, the factor sends your customer a notice of assignment, often abbreviated NOA, signed by you and the factor. It tells the customer that payments on your invoices now go to the factor, and where to send them.

Your customer’s payables team takes that notice seriously. In most provinces and US states, a customer that has received a proper notice and still pays the carrier may not be released from the debt, so it could be asked to pay the same invoice again to the factor. That is why brokers often refuse to change remittance details without a release letter from the old factor when you switch, and why paying a factored invoice into your own account creates a problem you have to fix the same day by passing the money on. The exact rules come from provincial or state law and from your agreement, so ask your lawyer if a situation is unclear.

Most factors also register their interest in your receivables in the provincial personal property registry, or with a UCC filing in the US. A lender or a second factor will see that registration, which is one reason you generally cannot factor with two companies at once.

• Keep a copy of every notice with the customer it went to, with the date it was sent.
• Check remittance details on each invoice before it goes out: a factored invoice must show the factor’s payment instructions, not yours.
• When you leave a factor, get a written release and send it to every customer that received the original notice.

What a factor will ask for

Setting up a factoring account takes a few days. Expect to provide your business registration and authority details, proof of insurance, a void cheque or bank letter, the owners’ identification, and a list of the customers you want to factor so the factor can check their credit. The factor will also search the registry for anyone else who already has a claim on your receivables.

After that, each invoice you factor goes in with the same paperwork your customer would want:

1. The invoice, with the customer’s load and reference numbers and the factor’s remittance details.
2. The rate confirmation that shows the agreed rate.
3. The signed bill of lading or proof of delivery, legible and complete.
4. Receipts for lumper fees or other reimbursed charges, and time records for detention.
5. A schedule of accounts listing every invoice in the batch with its customer and amount.

Missing or unreadable paperwork is the most common reason a factor delays an advance. The same habits that get an invoice paid by a customer get it funded by a factor: see how to invoice a trucking load.

What to compare between factoring offers

Headline fees are hard to compare on their own, because the rest of the agreement changes what you actually pay. Put each offer side by side on these points:

• Fee structure. A flat fee per invoice, or a fee that rises every 10, 15 or 30 days the customer takes to pay.
• Advance and reserve. How much is advanced, when the reserve is released, and whether reserves are netted against bought-back invoices.
• Extra charges. Wire or same-day payment charges, credit check fees, monthly minimums, application or termination fees.
• Volume commitment. Whether you must factor every invoice from every customer, or can choose invoice by invoice.
• Term and exit. The length of the contract, the notice needed to leave and what it costs to leave early.
• Recourse terms. The buy-back period and, for non-recourse, exactly which losses are covered.

Work through three or four of your real invoices under each offer, including one from your slowest-paying customer. The cheapest-looking fee can be the most expensive once a long-pay customer and a monthly minimum are counted.

How to record factored invoices in your books

The mistake to avoid is recording only the deposit. If you book the 1,800.00 advance as if the customer had paid, your receivables are wrong, the reserve disappears from your balance sheet and the fee never shows up as a cost. Record each step instead. Using the illustration above:

After step 3, the receivable and the reserve are both back to zero and the full 60.00 sits in a factoring fees expense account where you can see it every month. If GST/HST is on the invoice, the receivable includes the tax and the tax still goes to GST/HST payable when you invoice; factoring the invoice does not change the tax you charged. Ask your accountant how the fee itself is treated for sales tax.

Recourse factoring raises one more question: whether the arrangement is a sale of the receivable or a loan secured by it. Some accountants keep a recourse invoice in receivables and record the advance as a liability to the factor until the customer pays. Agree the treatment with your accountant once, then use it for every invoice.

Factoring, quick pay or a line of credit?

Factoring is one of three common ways to get paid sooner, and each fits a different situation.

• Quick pay is offered by many brokers: they pay your invoice within a few days for a fee taken off the payment. It needs no contract and works load by load, but it is only as good as the brokers who offer it.
• A line of credit from a bank lets you borrow against your business and repay as customers pay. Interest is charged only on what you use, and rates usually move with the prime rate, which the Bank of Canada influences through its policy interest rate. It is often the cheapest option, but banks want financial statements, history and sometimes personal guarantees, which newer carriers may not have.
• Factoring is based mainly on your customers’ credit rather than yours, so it is easier to get, and it includes collections. It is also usually the most expensive per day of cash, and it puts a third party between you and your customers.

Factoring tends to make sense for a new or fast-growing carrier with creditworthy customers and no bank history, for a fleet taking on a large customer with long terms, or for a seasonal crunch. It makes less sense when your margins are thin, when your customers already pay quickly, or when a line of credit is available. Many carriers factor only their slow-paying customers and collect the rest themselves. Before choosing, see getting paid faster on freight receivables: tighter invoicing and collections can shorten your terms without any fee at all.

How TruckerPro Finance handles it

Factoring in TruckerPro Finance starts from the invoices you already create from delivered loads. You set up each factoring company you work with, including its advance rate, its fee, whether the fee comes off the advance or out of the reserve, and whether the agreement is recourse or non-recourse.

You pick the invoices to factor and prepare the submission, with a schedule of accounts you can send to your factor. Each factored invoice is split into its advance, fee and reserve, which always add back to the invoice total, and you record the reserve release when the factor pays it. The notice of assignment is kept on file with the customer it applies to, and factoring reports show which invoices are factored and what the fees came to.

It works with whichever factor you use: you send the submission and schedule the way your factor asks, then record what they advanced and charged. Factoring is included from the Essentials plan. Compare the plans to see what each one adds.