Learn when 'Factoring' isn't a dirty word but a financial help to your trucking company.
By Steven Hausman, www.advancebcap.com/

FACTORING 101

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,  www.advancebcap.com

Lesson #1 - What’s Factoring?
If you don’t know much about the business of factoring, don’t feel lonely. Most Americans don’t, even a lot of business people. Factoring isn’t taught in most business colleges and seldom mentioned in business plans, yet it’s an essential part of the American economy. Factoring takes place in almost every industry but we’re going to deal exclusively with freight factors.

Demystifying Factoring
The concept of factoring isn’t hard to understand, but first we have to get past a couple of built-in confusions. Let’s start with the word itself. “Factor” is a math term that became a business term that evolved into one of those all-purpose words that are used in situations which have nothing to do with math or business.

A word employed in so many ways can get a little slippery. You may understand it in context but have trouble explaining exactly what it means. To complicate things, “factor” is both a noun and a verb, which makes it hard for the novice to get a grip. What’s a “factor?” It’s a business that factors. What’s factoring? It’s something factors do. Say what? Okay, this isn’t an English class, but you can see it’s easy to fall into round-robin definitions that mystify the uninitiated. So let’s demystify. We’ll start with a basic business definition and refine for trucking.

Definition: factoring is the sale/purchase of accounts receivable for a discounted price.

A Sale, Not a Loan 
Notice we said “sale,” not loan. It’s easy to mistake factoring for lending because in practice, the relationship between a factor and its client is a lot like lender and borrower. There are, however, important differences.

Eventually, we’ll go into all those differences, but for now we’ll just deal with how factoring typically works. Here’s an example (made-up names, of course). “Tailgate Trucking” is a young business long on enterprise and short on capital. Tailgate handles a lot of loads but its customers all pay in 30-90 days. Tailgate’s problem is that it has to pay its expenses—fuel, taxes, etc.—a lot sooner. 

Sounds familiar, right? Tailgate’s in a jam common to lots of trucking start-ups. It needs working capital but it can’t get a bank loan because its only real collateral is its rigs, which are already financed. Fortunately, so long as Tailgate has reliable customers it also has a solution.

How Factoring Works 
That solution is the factoring company, “Crown Factoring.” Crown will provide money to Tailgate based on Tailgate’s invoices. To a bank, an invoice is just paper, too risky for a loan.  To a factor like Crown, an invoice is a collectable debt, worth the risk.

Crown and Tailgate come to terms. Tailgate has invoices worth $10,000. Crown buys those at a discount. Just how much a discount is a matter of the market, but to keep it simple let’s say 8%, or $800. Crown pays Tailgate $9,200 for its invoices and assumes responsibility for their collection.

Now here’s why a factor isn’t the same as a bank. The transaction between Tailgate and Crown is a sale, not a loan. If Tailgate borrowed the money, it would still have the headache of collecting the debts as well as the obligation to pay the lender. Now that Crown has bought the invoices, it owns the debts.

So if Tailgate has sold those debts it’s no longer liable for them, right? Well, uh, maybe. That depends on whether the transaction has been recourse or non-recourse. You see–

Takeaway 
Oops! There’s the bell. End of our first class. We’ll go into different kinds of factoring next time, but here’s your takeaway from this lesson:  

• A factor is a company that pays money for your invoices.
• Factoring isn’t lending. The factor buys the invoices.

For many truckers factoring is often 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!