Quick payment: how factoring services help logistics companies
As is the case with many other industries, logistics companies often have to deal with long payment terms, a problem only exacerbated by late payments. This is a real predicament for companies already forced to operate with very low margins. Factoring providers often advertise by saying “Factoring means you get paid faster and can increase profits”. But how does factoring work, and what do you need to watch out for? Our blog article collects the most important facts and expert tips, so you can get factoring right.
Table of Contents
1. What is factoring and how can it help?
2. What does factoring cost?
3. What types of factoring are available?
4. Who does factoring benefit?
5. How factoring helps transport service providers
1. What is factoring and how can it help? Factoring is easy to understand once you know how transport service provision works. Basically, the transport company pays for everything in advance: they essentially loan the money for the transport to the transport customer, assuming the risk until the point at which they receive payment. And if they are unable to or do not want to transport the goods themselves, they pay another company to do it for them. Factoring works on the same principles: companies can reduce their financial risk by hiring a factoring company to pay the invoice in advance. Factoring is a financial service in which a company sells unpaid debts, which are not yet due, to a factoring company. That company then assumes all rights to the debt and pays the invoice immediately upon receiving proof that the transport order is complete. More specifically, this usually means that anywhere between 80 to 90% of the total invoice amount will be paid to the transport company within 24-48 hours, according to most factoring service providers. The remaining amount is paid as soon as the transport customer has paid the invoice in full to the factoring company. Transport companies thus do not have to wait a long time to receive payment. They also have the option of outsourcing the dunning process and the risk that their customer will not pay, that is the del credere risk.
2. What does factoring cost? The transport company hiring the factoring service is responsible for paying factoring costs. These costs usually consist of two main components. • Factoring interest This interest is similar to the current account interest you are familiar with from the bank. The rate is based on the credit risk of the company hiring the factoring service and that of the debtor. The amount of interest is calculated beginning from the moment the factoring service pays the invoice to the moment that the debtor pays the factoring service, that is always based on the actual payment term. The quicker the debtor pays the factoring service, the lower the interest that the transport company owes. • Factoring fee This is the fee the factoring service charges for assuming the risk that the debtor will not pay the invoice. The fee is based on the invoice amount, number of invoices and the customer. The factoring fee usually costs between 0.5 and 2.5 percent of the total invoice amount. In short, the factoring fee increases together with the invoice amount. The more financially secure a debtor is, the lower the factoring interest.
3. What types of factoring are available? There are many different types of factoring available, each offering different options. Here is a short summary of the most popular types of factoring: • Full factoring is the most common type of factoring. The factoring service assumes all risk. Even if the debtor ends up not paying the invoice. The factoring customer knows that no matter what, they will receive their payment on time. • Recourse factoring is factoring that does not include debt protection. If the debtor does not pay, the factoring customer assumes the debt. • In the case of open factoring, debtors are informed that their debt has been sold. In Germany, full factoring and open factoring are usually combined. • If the debtors are not informed that the debt has been sold, the process is known as silent factoring. • Reverse factoring is used to secure discounts when purchasing products or services. The debtor initiates the reverse factoring process, offering the benefits of factoring to the supplier. The factoring service provider pays the invoice immediately, allowing the debtor to receive a discount and a longer payment term. • Full service factoring also includes the dunning process and a debt collection service.
4. Who does factoring benefit? Many small and mid-sized companies work with low profit margins and may be worried about using factoring due to the extra costs. However, over the long term, factoring can increase profits, as it allows a company to take on more orders and minimises the risk of a debtor defaulting on payment. Plus, there is no need to finance orders in advance, so the company has more capital to invest.
5. How factoring helps transport service providers Having invoices paid in advance by a factoring service improves a logistic company’s credit and liquidity, because they no longer have to wait long periods of time to receive their money. Expenses are paid immediately and the remaining money can be invested. This gives a business more freedom to improve, potentially increasing profits, which in turn provides an important competitive advantage. All in all, factoring minimises risks and administrative effort, allowing companies to concentrate on their core area of business. Just as when entering into any other contract, it is important to carefully examine terms and compare service providers. Terms should be easy to understand and transparent, even without the help of a lawyer. This will help you to find the factoring model that works best for your company.
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