How should factoring companies be selected? Let’s look at four of the most important factors you need to look for before you sign up with a factoring company.
1. Rate – That’s the factor that everyone is looking for. They want to know how much a factoring company will charge them for factoring the loads, and everyone tries to get the lowest rate possible. Now that is great if you get the low rate because the more money you save, the more money will end up in your pocket. However, it’s not the only factor you need to consider.
2. Reserve – Factoring companies require you to keep some of your funds in reserve just in case something goes wrong, and they don’t get paid for the transaction they’ve funded. They want to build up a certain amount in reserve, so they can tap into that capital if needed. For example, a low rate of, say, 2% with a 10% reserve is already not so attractive because you will only receive 88% of your money since 10% will be tied up somewhere in reserves. Yes, you will eventually receive it, but it’s money that you cannot access right away. So again, your goal is not just to get the lowers possible rate but also the lowest possible reserve requirements. Or, if possible, try to find a factoring company that doesn’t have a reserve requirement. That’s ideal because then you just pay a percentage for factoring, and you keep the rest of the money.
3. Recourse and Non-Recourse – Again, in simple words, recourse means that if the factoring company doesn’t get paid by the shipper for whatever reason, they will come to you and say, “Sorry Mr. Broker, we did not get the money from the shipper, so you have to pay us back.” This is not very good for you as a freight broker. But there are factoring companies that do offer a non-recourse option. That means that even if they don’t collect money from the shipper, it is no longer your problem. That is now factoring company’s problem. In most cases factoring companies will charge you a higher rate for Non-recourse factoring. Recourse factoring will always have a lower rate than non-recourse factoring because non-recourse carries a higher risk. We personally would choose non-recourse even with the higher rate, but that’s our preference because we want the factoring company to carry all the financial risks.
4. Terms – When we say Terms, we’re talking about the terms of your agreement with the factoring company. Some of the companies want to lock you into a long-term contract. And if you want to cancel sooner, they will charge you very, very high fees, which is not a good scenario. You want to have flexibility and be able to switch factoring companies if needed. So, read through the contract, pay special attention to the termination terms. Will you be able to cancel the contract? If so, what is it going to cost you?
We hope that now you have learned a few things about factoring, why freight brokers are using it, and what you need to look out for when selecting a factoring company for your freight brokerage.