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Time Costs Money (Yours)
By Steven Hausman, CEO, 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.
This is the nineteenth lesson in our series on factoring for truckers. For the past several months we’ve been reviewing last year’s factoring lessons. This month is the last of our reviews. Next month we’ll start our third semester on truck factoring. (Can you spell ‘end of semester finals’?)
Third in a 3-part series: How Factors Determine Rates
This lesson is the third of a three-part series on how factoring companies determine rates. Pay attention, because this information can help you keep down the money you pay for a cash advance.
Last month’s lesson, the second in our series, covered how your rates are affected by the creditworthiness of your customers. One of the differences between a bank and factor is that the factor is less concerned with how financially solid your business is than how solid your customers are. That’s because he’s buying your invoices to them.
This lesson, the final of our three-parters, is about invoice aging and how it affects the “reserves” held back by the factor. Those reserves are your money and you’ll be paid them, but how soon (and how much) is another matter.
Lesson #19 – Invoice Aging: Time Costs Money (Yours)
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 factor determines your rate through three variables: (1) the invoice volume you finance, (2) your customers’ creditworthiness, and (3) bill aging.
Our Story So Far
Let’s return to our examples from Lesson 18. FastFleet is a small thirty-tractor company owned by veteran trucker Herb Gozersky and two investors. It’s been in business eleven years. HotDog Delivery is a two-rig meat hauler run by Mike and Enrique Ortiz. It’s only two years old. Both have been accepted as customers by Crown Factoring, a long-established and reputable firm.
Crown factors FastFleet’s account, which is $250,000 a month, at a discount of 3%. That means that Crown keeps 3% of the total invoice value (in this case, $7,500). Crown factors HotDog’s account, which is substantially smaller ($35,000) for a discount of 6% (or $2,100).
The discount is another word for the factor’s profit. That’s the money it keeps. However, almost all factors also keep additional money called the Reserve. The reserve is held back as a contingency fund for payment delays. As debts are paid, the reserve is released.
Crown has held back 10% of FastFleet’s advance ($25,000) and 20% of HotDog’s advance ($7,000). The reason for HotDog’s higher reserve is simple. HotDog’s customers aren’t as reliable as FastFleet’s. As a startup business, HotDog has sometimes made deals with poor credit risks, a chancy but understandable practice.
What Happens Next
Over the next thirty days, half of FastFleet’s customers pay their bills and with each payment, Crown releases that portion of the reserve. Within a month, FastFleet has been paid about $13,000 of its reserve. Predictably, HotDog’s customers aren’t as prompt. Only a quarter of them pay within thirty days. HotDog gets back $1,740 of its reserve, but Crown is still holding most of it.
Another thirty days passes. Now all of FastFleet’s customers have paid. Crown pays FastFleet’s remaining $12,000 in reserves minus $3,600.
Hey, where does that $3,600 come from? Nobody said anything about extra charges! As a matter of fact, they’re part of the contract. We’ve just skipped over that clause until now. Most factors charge an additional percentage for payments over thirty days. The method of calculation varies so widely it’s pointless to go into it. The important thing is that you should know what it is before signing with a factor. If it seems excessive, compare it with other factors’ aging charges.
Late Payment Penalties
In this case, Crown charges 1% for each ten-day period, a common formula. Of course it calculates its percentage based only on what’s still owed, not for the entire advance amount. Even so, the amount is pretty hefty: slightly more than half of Crown’s discount.
FastFleet gets back $8,400. It has paid $11,100 to factor $250,000. That equals a bank loan of 4.5%. As of this writing, banks are making business loans for much less than 4.5%, but considering that FastFleet wasn’t in a position to borrow from a bank, it got a reasonably good deal.
HotDog fares considerably worse. By the end of 60 days, two of its clients still have not paid their invoices, worth $8,000. They only pay in full by the 90th day and HotDog gets back only $2,000 of its advance. HotDog’s factoring experience has been an expensive one. It cost Mike and Enrique Ortiz $7,100 to get an advance of slightly more than $20,000.
An Expensive Lesson
There’s a lesson here and it’s this. Most of HotDog’s charges came because of late payers. Factoring is not advantageous in the case of chronically late debtors. The invoice to sell to a factor is one that you know will be paid in thirty days (more or less). Chronically late payers could wind up costing you as much as half your invoice! Is it worth it?
Charging for aging invoices isn’t a factoring “trick.” All factors do it. As with the reserve, you should know about the fee before you sign. Again, if it seems high, check out the competition. Watch out for factors that mumble over that part of the contract.
That said, the majority of factors don’t like late payers any more than truckers do. They’d prefer to make all their money back in thirty days and use it to make another cash advance. The aging charge is costly to the customer but because it applies only to a small part of the advance, it’s usually only enough for the factor to break even.
There goes the bell! But for once we’ve finished the lesson. This completes the third part of our multiple lessons on how factors determine rates. It may be dull when it’s about fictional examples, but you can be sure it’ll be fascinating when it’s about your business. If you’ve paid attention, you’ll have a good idea of what to expect.
Takeaway
Okay, no test.
Don’t everyone crowd the door at once. Here’s your takeaway for today’s class.
- The Reserve is the money the factor holds back for late payers.
- The size of the reserve is calculated by your customers’ credit rating.
- Your reserve is eventually released to you but only after deductions for late payments.
- Late payments can cost you money.
- The best customers to factor are those that reliably pay in 30 days.
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!
http://www.advancebcap.com
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