Invoice factoring is a popular solution used by oilfield transportation companies with working capital issues due to slow-paying invoices. This article discusses how factoring works and helps you determine if it’s the right solution for your company. We cover:
- Slow cash flow is a problem
- Ask clients to pay sooner?
- Invoice factoring financing
- Advantages and limitations
- Does your company qualify?
1. Slow cash flow is a problem
Oilfield transportation companies can be very profitable but are also challenging to operate. They often have higher expenses than conventional transportation companies. Expenses include the equipment to handle specialized loads (e.g., oversized, fluids, etc.), experienced drivers that can manage demanding schedules, etc.
However, transportation companies often have to extend 30- to 60-day payment terms to their clients. Offering payment terms is a standard industry practice since larger clients often demand payment terms in their contracts. Unfortunately, offering payment terms is also a common source of cash flow problems for small and midsize oilfield transportation companies. Let’s examine this situation in more detail.
On the expense side, the transportation company has a number of operating expenses that must be covered regularly. These expenses must be paid quickly in most cases. On the other hand, offering payment terms to clients delays the corresponding revenues by 30 to 60 days. This situation creates a shortfall that the company has to cover with its cash reserve.
This situation is not a problem for companies with substantial cash reserves. However, companies that don’t have a sufficiently large cash reserve can get into financial trouble. And if those problems are not managed correctly, they can spiral out of control.
2. Can you ask clients to pay sooner?
One strategy to improve your cash flow is to offer early payment discounts to select clients. These clients get a discount, around 2% (varies), if they pay your invoice in 10 days. Otherwise, they pay the total amount on their usual terms.
You may be tempted to offer early payment discounts to your slowest-paying clients – hoping they will pay sooner. This strategy is not recommended and can backfire. Instead, offer these discounts only to your best clients who pay on time. Clients who take your offer will see it as a benefit, since the discount increases their profitability.
Note that clients have the option to take, or not take, the discount when offered. Consequently, you can never be 100% sure they will pay early. Early payment discounts can work well for companies with tight cash flows or minor problems. However, they may not be sufficient to help a company with ongoing cash flow problems. These companies should consider financing instead.
3. Invoice factoring financing
Companies that need to improve their cash flow reliably should consider invoice factoring. Factoring helps oilfield service companies by accelerating the revenues tied to slow-paying invoices from creditworthy clients. This solution provides the funds you need to cover operational expenses and grow the business.
Factoring transactions are not usually structured as loans. Instead, they are structured as asset purchases. The factoring company buys your invoices (an asset) and provides an immediate payment for them. The advantage of using a purchase structure is that it simplifies the qualification requirements.
a) How does factoring work?
Invoices can be financed using one of two different models. Single-instalment purchases are simpler. They are popular with small oilfield transportation companies and owner-operators.
The factoring company buys the accounts receivable using a single payment. The payment covers up to 98% of the invoice, though this amount varies by transaction. The part that is not advanced to your company becomes the factoring company’s fee.
Two-instalment transactions are common with midsize and large oilfield transportation carriers. The first instalment is deposited to the company’s bank account once the load is delivered. This payment covers up to 90% of the invoice. The remaining 10%, less the factor’s fee, is deposited as a second instalment once your client pays the invoice in full.
To learn more, read “What is Factoring?” and “How Does Factoring Work?”
4. Advantages and limitations
Companies looking to use factoring should consider the advantages and limitations of the solution before making a decision.
a) Advantages
While factoring has several advantages, most transportation companies consider the following benefits to be the most important.
i. Improves cash flow quickly
The most important advantage is that factoring can quickly address your cash flow problem. It provides financial stability that enables you to run your company more effectively.
ii. Offer terms comfortably
The financing line lets your company offer payment terms to clients while minimizing concerns about cash flow. Consequently, the line can be used as a tool for growth.
iii. Flexible, adaptive lines
Lines are flexible and are designed to be adaptive. The line can easily be increased as the number of loads you pull from creditworthy clients increases.
iv. Easy to obtain
Qualifying for factoring is easier than qualifying for a comparably-sized loan or line of credit. This is due to the simplified due diligence requirements.
b) Limitations
Factoring is not for every company or situation. It has two limitations that transportation companies should consider.
i. It solves only one problem
This solution helps only those companies whose main cash flow problem is related to slow-paying invoices. Factoring cannot help companies whose cash flow problems are related to profitability or other issues.
ii) It’s more expensive than a loan
Factoring lines are more expensive than comparably-sized loans and lines of credit. Consequently, the lines work best for companies whose gross margins exceed 20%.
5. Does your company qualify?
Factoring financing has simpler qualifications requirements than conventional loans. Furthermore, factoring lines don’t have the onerous covenants associated with conventional financing.
a) Creditworthy customers
Factoring companies base their decisions, to a great extent, on the commercial creditworthiness of your invoices. Consequently, your customers should have good commercial credit.
b) Free and clear invoices
Your invoices cannot be encumbered by a lien or a hypothèque. They must be free and clear, as they are the asset the factor purchases.
c) Profit margins over 20%
Factoring is more expensive than conventional financing. Consequently, it works best for invoices with profit margins over 20% that pay in 60 days or less.
d) No risk of immediate bankruptcy
The solution can work well for companies that are in trouble and need to be turned around. However, the company must not be at immediate risk of formal insolvency.
Get more information
We are a leading factoring provider in Canada and can offer competitive plans to oilfield transportation companies. For information, get a factoring quote or call us toll-free at (877) 300 3258.