Time Value of Money: Knowing Your Effective Rate per Mile
Most of us are familiar with factoring companies, as well as the quick pay programs that some freight payment companies offer. There is a time value to money (receiving a dollar today is worth more than receiving a dollar next month), but are these ‘incentive programs’ really worth the fees? And aren’t factors just for companies that aren’t doing very well, and having cash flow issues?
We are going to address the second statement first. Traditionally this point of view was correct, and factoring companies were there to service the smaller companies that were unable to get a more traditional financing arrangement to help fund working capital (e.g. Line of Credit). At one time it was not unheard of that some carriers would look at the use of a factoring company when evaluating carriers for brokered loads. In today’s economic reality some larger, more stable companies have started to turn to factoring companies in lieu of an operating line of credit facility. The reason for this is depending on the risk profile of your customers you may be able to get the percentage rate that the factor charges into the range of what a bank will charge for an operating line – into the 3.5-5% area for customers that meet the factor’s credit rating scores. With most factoring companies you no longer need to do an “all in” arrangement so you could just factor an amount that will cover your operating needs. This may make this a potentially interesting arrangement for a fleet that is in need of a large scale equipment refresh, and needs to maximize their ability to finance these investments. Additionally a factor can provide funds as quickly as the same day if a wire option is chosen or the next day if using an ACH. In terms of drawbacks, these are shared with the Quick-Pay programs so we will discuss them at the same time.
Quick-Pay programs offer another way to accelerate the payment cycle. Many of them are structured as a 5% discount to be paid in 5 days and then a second option in the range of 3-4% to be paid in 10-15 days (the second option tends to vary). For larger carriers, the discount may be between 1-2% and 0-1% respectively. The discount may vary between freight payment companies and brokers, but they follow the same principles – accept a discount and we will pay you quicker. Part of this discount is to cover the cost of fronting the payment to you, while they are waiting to get paid by their customer. However these are also a profit generator as the cost of short term financing the fronted funds is nowhere near the discount they are asking. The true cost of advancing the funds to you is less than half of a percentage point so they are making a decent profit on the spread. One thing to consider with this scenario is that in the best case scenario you are paid via EFT or ACH after the waiting period.
Both scenarios share some drawbacks. First of all, you are taking a discount to get paid quicker than the normal 30-45 day terms. Using a very simple example, if you charged $2.00 per mile all-in, and you have to accept a 5% discount under either scenario, that is the same as only having charged $1.90 per mile. You need to make sure that you have a good handle on your operating costs to ensure that this does not put you into a loss position, especially after allocating for fixed overhead. You need to consider that many of these freight payment companies have already been working at getting the rates reduced, so have you really left enough margin in the rates to allow for an additional discount? Another consideration in factoring is if the factor has recourse or not. Having recourse means that you have assumed the risk of non-payment by your customer. This will generally reduce the discount rate (in some cases, by a significant amount). There may be an additional holdback involved – as an example, 80% of invoiced amount next day via ACH, a 5% discount on the total amount and then the remainder after the customer has paid the invoice. If the customer defaults on the invoice then the factor can come back at you for the advanced amount.
So, now we offer a few generalized statements in conclusion. First, is that any quick-pay solution likely has some hidden costs in terms of how quickly you receive the cash. These options are generally non-recourse, so the payment company takes on the risk of default. However the delay between when the payment is processed, and the receipt of the money needs to be taken into account when determining if the discount is worthwhile taking. A similar argument exists for the use of factoring companies. One notable exception is with a customer that takes extended payment terms. A recent example shared by a client, was a major manufacturing company whose standard payment terms were 120 days, and generally stretched closer to 150 days. In an extreme example like this the discount required for a quick pay may be worth it as the lost interest on the money will be close to the cost. However unless you are a small cash strapped carrier, the discount cost is unlikely to be worth getting paid in 5-10 days instead of 30. The only other exception would be if you are using these scenarios to avoid or replace an operating line. There will be some fairly complex calculations (that are beyond the scope of this discussion) to determine which is the best option for your situation. Remember to keep your margins in mind when determining if you can afford to use either of these options, especially for dry freight lanes that will have more “commodity” pricing as opposed to more specialty work such as temp control or flatbed. Finally, if you have to use these services, like anything else, try to negotiate a better rate where possible. This is more likely with a factoring company, but if you are doing a large amount of business with a company that offers a quick pay option you may be able to negotiate a better discount rate or a better payment vehicle (wire or ACH instead of a check). Regardless the calculations will be different for different carriers and even different customers and/or lanes. Know your costs, follow best practices, negotiate your best deal and monitor on an ongoing basis to ensure that the assumptions have not changed.
These two options may not be your preferred vehicles, and for some companies it would never be a consideration, but they are good to keep in the tool box in case if, and when they are needed. It’s just like in baseball – any pitcher can throw a fastball, most can throw the curve, but to be highly successful you need to have an off-speed, a split finger, a cutter, a knuckler and maybe even an Eephus to match specific batters and counts. You may not ever use them but understand how and when they work and then have them as an option if the situation arises.