First in a 2-part series: How Factors Determine Rates 
By Advance Business Capital

Welcome to “Factoring 101,” your continuing online education in the nuts-and-bolts of factoring. All of our lessons are bite-sized chunks of information you can read and digest in a few minutes. This series is provided as a public service by Advance Business Capital.

Quick review. So far we’ve learned:  

• Factoring is a form of financing suitable for any business that issues invoices paid in 30-90 days.
• Unlike banks, factors are buyers and not lenders. Banks lend you money based on collateral. Factors buy your invoices, but not for the full amount.
• Recourse factoring means if your debtor doesn’t pay your invoice, the factor has legal recourse to get its money back from you.
• Non-recourse factoring means if your debtor doesn’t pay, the factor is stuck with the debt. It has no recourse. For obvious reasons, Non-recourse is more expensive than Recourse.
• Factoring is a three-party transaction. The parties are the seller (the carrier), the debtor (the shipper) and the buyer (the factor).
• There are three parts to the factoring transaction: the Advance (the money you get immediately), the Discount (the factor’s profit) and the Reserve (money held back until paid by debtor).

The Three Variables 
When a company agrees to factor your loads, it considers three variables to determine rates. These are:  

• your monthly financed volume
• the credit worthiness of your customers
• bill aging (or how long it takes your debtors to pay)

As always, we use examples to make the abstract concrete. The first of our imaginary truckers is FastFleet, a small company of thirty tractors run by longtime trucker Herb Gozersky and owned by himself and two investors. It’s been in business eleven years. Our other example is a much smaller company, HotDog Delivery, a two-rig meat hauler run by Mike and Enrique Ortiz. Both companies have made applications to Crown Factoring, an established and reputable firm.

Volume Discount 
As with any kind of business, size lowers unit cost. FastFleet generates $400,000 worth of invoices each month. Some of these are quick payers, which FastFleet doesn’t want to factor. Like most factors, Crown doesn’t insist on factoring all accounts receivable, so it agrees to factor $250,000 for the month of June. Crown and FastFleet have an informal understanding that this will be the usual monthly volume, depending on business conditions. (The understanding is “informal” because it’s not enforceable. If FastFleet factors less, there is no penalty.)

The monthly volume, however, does enter into Crown’s discount rate. It advances FastFleet 97% of invoice value. HotDog Delivery, on the other hand, does a much smaller volume, say $35,000 a month. HotDog wants to factor all its accounts, which is acceptable to Crown, pending credit checks. It advances 94% of invoice value to HotDog.

Sidebar: Crown has two separate kinds of deal with FastFleet and HotDog. Both are factoring but one is Recourse and the other is Non-Recourse. You’ll find definitions of each in the review at the top. Recourse means a better rate. Crown has offered that only to FastFleet and not HotDog because FastFleet has the capital to make good any unpaid debts. HotDog doesn’t.

Determining the Discount 
FastFleet’s business is more desirable than HotDog’s and therefore it’s in a position to strike a better deal. If Crown declines to factor FastFleet, Herb Gozersky can go elsewhere. However, Crown has offered a highly competitive advance fee (its discount) of 3% of invoice value. Gozersky gladly takes the offer. Crown makes a less generous offer, 6%, to the Ortiz Brothers, double its fee to FastFleet. Still, it’s not a bad deal for a business only a couple of years old still in baby-step stage. Mike and Enrique also decide to take the offer.

Sidebar: “Discount” is the traditional term used for factors to indicate their fee. It’s a little confusing because we’re accustomed to thinking of discounts as favoring the customer (such as “Factory Discount Furniture”). In retail, a large discount means savings. In factoring, the larger the discount, the more you’re paying.

Let’s reduce percentages to dollars. In return for $250,000 worth of invoices, Crown advances 97% of invoice value to FastFleet, or $242,500. Crown’s discount (its profit) is $7,500.

Turning to HotDog, in exchange for $35,000 worth of invoices, Crown has advanced 94%, or $32,900. In HotDog’s case, Crown’s discount (profit) is 6% or $2,100.

Volume vs. Financed Volume 
Notice we said earlier that the factor considers the monthly financed volume. FastFleet does almost twice as much volume as it factors, but that figure is irrelevant to Crown, which is only concerned with invoices that will make it money.

Aside: Let’s suppose FastFleet loses a key customer and its invoice volume dips by $50,000, to only $200,000 a month (down from $250,000). Will Crown adjust its discount? Possibly yes. That’s a drop of 20% in sales. Crown is now making less money and it may charge FastFleet more for the money it does advance. How much? Maybe half a percent; not a lot because FastFleet is still a desirable customer. That, however, is only hypothetical.

So FastFleet gets an advance of $242,500 and HotDog gets an advance of $32,900. Since Crown is well known for its fast advances, that means that within 24 hours, both its customers will receive checks for those amounts, right?

Sorry. Wrong. Neither company will receive its full advance, nor did either expect to. That’s because factors usually hold back part of the advance as a reserve.

What’s a reserve? Dang! There’s the bell. If you don’t know what the reserve is, look at the top of this lesson. Right. It’s the amount held back in case of debtor default. But how much is that? How do factors determine reserves? We’ll go into that question in our next lesson.

Takeaway 
Don’t everyone crowd the door at once. Here’s your takeaway for today’s class.  

• Factors consider three variables in determining rates.
• Those variables are finance volume, customer credit rating and bill aging.
• The greater your invoice volume, the smaller the factor’s discount.
• The discount is another word for the factor’s profit, the money it keeps.

For many truckers factoring is a good deal, but of course, not always. Stick with this course and you’ll learn how to tell good deals from bad, and how to make factoring work for you. See you next class!

www.advancebcap.com