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3 Minute Factoring Video
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What is Factoring and How does it Work?
In recent years, factoring has played an ever-increasing role in the transportation industry, often replacing traditional financing methods such as bank loans and lines of credit.
The dictionary describes factoring as the business of purchasing and collecting accounts receivable or of advancing cash on the basis of accounts receivable. In order to better understand this definition, consider the following example:
Sam is the owner of a small but growing trucking company with 12 trucks. Sam’s company hauls freight loads for several large shippers and freight brokers. Although Sam’s company is showing healthy profits, he continually experiences cash flow problems due to the fact that his customers often do not pay him for up to 60 days (or more). Many trucking company owners face these same problems because a large proportion of their operating costs such as driver pay and fuel costs cannot be paid in 60 days. For various reasons common to many trucking companies, Sam’s bank is only willing to grant him a very small line of credit that is not nearly enough to solve Sam’s cash flow issues. In order to increase the supply of cash to his business, Sam turns to a factor who “purchases” a large portion of Sam’s outstanding accounts receivable, providing immediate cash to Sam’s business.
After evaluating the creditworthiness of the debtors on Sam’s accounts receivable list, the factor decides to purchase a large percentage of Sam’s receivables and immediately provides Sam with a cheque for the full amount, less a small reserve. When Sam’s customers pay their outstanding freight bills, the factor refunds the reserve to Sam, less their discount (interest) fee. The discount fee that the factor applies to Sam’s invoices depends upon several factors including the number of invoices Sam factors on a monthly basis and the length of time Sam’s customers take to pay their invoices. The end result is that Sam has solved his cash flow problem by turning his freight invoices into cash in time to pay out the expenses that he incurred to earn them.