The Factor Guru

Tips on accounts receivable financing and business practices.

Archive for category Operations

The Point of Verifications

Feb 21

Posted by Gen Merritt in Operations | Comments off

“Trust, but verify” was a signature phrase adopted by Ronald Reagan. Factors have also adopted this phrase ingraining it into their process. Verification of invoices is a key piece in how a factoring company confirms the validity of invoices and that those invoices will in fact be paid to the factor. Several years ago, the Commercial Factor published an article written by Allen Frederic on Verifications, the 5 W’s. This article is one I found that provides a good overview on this process and what is considered a verification, while also sharing some examples.

Once in awhile, however, a new prospect with a ‘rush’ closing comes along which can create tension and add stress between the sales and the credit departments within the factor’s business. This is normal.

What is not normal, however, is for a factor not to execute the verification process because of a rush situation or because of this added stress. Have you heard that other phrase about how stressful situations reveal character? That principle holds true here as well.

As many of you know, we all share stories after time has elapsed. These can be expensive lessons for those with the story to share, but they can also become learning opportunities for others. Over the past few years, I have come across a few stories that all focus on the same underlying issue: Bulk Verifications. (I really do not know that this is the correct wording; it’s just the wording we’ll use for today).

This occurs when a factor attempts to contact the debtors’ accounts payable departments to verify invoices. Instead, the debtor is only able to verify the balance owed (in bulk) or the checks to be written (i.e., $50,000 in outstanding receivables) – they cannot confirm the actual invoice numbers or details for that open balance.

In a rush situation, the factor may look at the invoices the prospective client provided for purchase, which total a little more than $75,000, and incorrectly assume (i) the $25,000 in additional invoices are probably just new invoices that are not in the accounts payable system yet and (ii) that the $50,000 in invoices have been verified. Yes, I did say incorrectly. This response should not be considered verification.

Why? Sometimes, in those rare situations, the prospective client could have sold the factor invoices that had already been paid and/or included some fraudulent invoices in their schedule or batch. When the $50,000 that the debtor has on the books later comes through the factor’s lockbox, that check may not include invoices that the factoring company purchased, meaning those funds will more than likely be processed as non-factored and returned to the client. Where does this leave the factoring company and the $75,000 they sent to the client?

There are other situations where bulk verifications may be the only way the debtor will confirm, and the factoring company may decide to accept this form of verification. Consideration for this may include the debtor’s concentration level, prior experiences with the debtor, copies of check remittances from prior payments received by the client, type of invoicing and backup, etc. The point, however, is to be aware of the potential for this risk and to ask yourself, “How do I know that the invoices I am factoring will be paid?” After all, that is the point of verifications.

So, next time you are in the middle of that rush closing and stress levels are on the rise… be sure to follow your process. Don’t take a shortcut or an easy way out hoping everything will turn out okay. Reveal your true character as a factor – “Trust, but Verify.”

Wishing you success. The Factor Guru.

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Clients’ Failure to Pay State Franchise Taxes is Risky Business for Factors! A guest blog by Scot Pierce

Jun 15

Posted by admin in Operations | Comments off

Factors need to be aware whether their clients are in good standing with the states where the clients conduct business.  Most entities doing business in a particular state are required to pay state franchise taxes.  Paying the taxes helps maintain an entity’s legal standing to do business in the state.  Failure to pay, however, ultimately leads to tax forfeitures which can be a big problem for factors.

Tax forfeitures affect an entity’s liability protection.  You are all familiar with the various entity forms.  You know that some entity forms provide limited liability for owners, shareholders and partners.  These include limited liability companies, S corporations, C corporations, limited liability partnerships, and professions corporations.  You also know that sole proprietorships, general partnerships, joint ventures and DBAs have no limit on liability.  Entities can lose their liability protection by failing to pay state franchise taxes.

Using Texas as an example, entities have three levels of standing.  They are (1) “Good Standing,” (2) “Not in Good Standing,” (3) and ‘Temporary Good Standing.”  Most states have the same or similar designations.  “Good Standing” means the entity has filed all franchise tax reports and paid its franchise taxes in full.  This allows the entity to continue doing business in the state.  “Temporary Good Standing” is really no reflection on the entity itself.  This simply means that the state has not yet processed the franchise tax reports. Until it does, all entities are granted temporary good standing.

“Not in Good Standing,” however, is very different. “Not in Good Standing” is a red flag for factors.  It means that the entity has not paid its state franchise taxes and has, therefore, forfeited its right to do business in Texas.  In practical terms, this means the entity is now operating as an assumed name or DBA so any shareholders, owners or partners are not protected personally from liability for debts incurred while the entity was “Not in Good Standing.”  Or, to be more direct, you are now factoring a sole proprietorship or general partnership.  My experience is that this not only can affect how you factor the client and perfect your security interest, but it is also a red flag that you may very well be factoring into a liquidation.

Because of the effect of failure to pay state franchise taxes, I recommend factors be vigilant in checking this.  Usually, the state comptroller’s office will have this information.  If you have a client whose account status changes for the worse, you should immediately contact the client to learn why this has happened and whether the client intends to correct the problem.  This may allow you to catch a failing business early on and take appropriate steps to protect yourself. Or, it may allow you to avoid factoring a business that just wants your money while intending to file for bankruptcy protection. The bottom line is factoring a client who is not paying its state franchise taxes can be a recipe for disaster.

About the author:

Scot Pierce is a partner with the lawfirm of Bracket & Ellis, P.C. located in Fort Worth, Texas.  He has represented a number of factors with commercial litigation and bankruptcy issues.  He also regularly writes articles and presents speeches on creditor issues, including an upcoming teleconference on Issues to Consider when Litigating against Account Debtors.  He can be reached at 817/339-2474 or spierce@belaw.com.

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A Look Back and Ahead

Mar 3

Posted by Gen Merritt in Operations | Comments off

2009 was a tough year. That is all I hear. For the existing portfolios, revenues were down for the most part last year; some publications have noted a 20% to 40% downturn last year resulting from the economic decline. Note that much of this may be dependent on the industry in which a factor may have a niche. Factors have been increasing their monitoring procedures to stay more in tune with their clients’ businesses and collateral performance. More research and credit limit adherence is being required for debtor credit. Think about what it says when bankruptcies increased 25% to 50% over 2008; tax lien filings increased over 25% from the prior year.

For new business, many of us have looked at more and more prospects to ultimately only fund the same number of deals. Issues arising from the economy last year have spurred additional due diligence and research on these prospective clients to ensure a long standing relationship will exist, or can exist in the first place. The question that always comes to mind: can you get out tomorrow?

So, where does that leave 2010? Well, we are well into the first quarter and business opportunities have been increasing, provided you have the capital available… but that is another discussion for another day.

By now, you hopefully have already evaluated your portfolios to determine areas of potential loss and/or weakness. You have also by now identified areas of improvement in your operations and portfolio management to help ensure proper checks and balances internally. For an extreme example, does your account manager handle the verifications, daily fundings, collections, and payment application for their clients? How would you know if something arose that should be a red flag? Maintaining appropriate checks and balances can be critical in today’s environment. Establishing certain communication protocols both internally and externally can prove to be invaluable within an operations department.

The recent increase in deal flow should, however, not equate to reducing the recently increased monitoring and account management standards. This year will be just as challenging for many as last year. Time and time again, I hear that factors are going back to the basics: maintaining verification and collection efforts, monitoring collateral trends in purchases and cash  management, reviewing and adhering to debtor credit limits, and understanding the billing of the client and what they do (i.e., industry in which they operate, etc). Factors are also paying more attention to early warning signs that may be indicators for potential concerns.

All I can say is be prepared… be proactive and not reactive, as they say. Surprises are not always a good thing.

Wishing You Continued Success. The Factor Guru.

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Financial Reporting… a telling story…

Oct 13

Posted by Gen Merritt in Operations | No Comments

Ever wonder if you really need to look at financial statements on your clients? Yes, most factors will review the balance sheet and income statements initially, during their due diligence. Most even include financial reporting in their factoring agreements with their clients. Maybe not every factoring company chooses to do this, however, based upon their business model. Some factors focus on small, niche factoring or more collateral-based, hard verification transactions. They may determine that for smaller deals, receiving and reviewing this information is not as important during the initial underwriting process. But, here is the question, assuming you don’t have this type of business model, what about after the deal is funded?

Depending on who you talk to, you may get a different answer… only on those clients that have facilities or fundings over $100,000, over $1,000,000 or more (again, depending on who you ask) or to getting financials on every client either monthly, quarterly or annually. For those that do have certain policies in place, here is my real question: what do you do with them?

Hopefully, this is not just information that is glanced at and put in the client’s file. But, as I have been frequently asked, “What does it matter? Don’t we just need to look if they’re making or losing money?” There is no quick explanation to this question… but the answer itself is easy: No.

For one, many companies today are losing money. Secondly, if you only evaluate financial performance once, you have no trend of data for which to compare the company’s performance. Finally, it is important to compare the client’s data to your data, as the factor. What does this mean? We’ll get there… this article is not about how to read financials, but I did want to take a moment to identify the relevance from reviewing and trending all of this information. Please understand that for most of your clients, it will actually feel like you are just reviewing data and then putting the financials in the client’s file. That’s okay. For many of your client files, this is just a good check to keep you informed of what is occurring in your client’s business.

After all, factors generally evaluate their receivables weekly, review trends monthly, if not more, perform verification and collection calls and other protocols to prevent and manage risk. But, sometimes exceptions occur or complacency arises. Or, for those new to factoring and/or lending, maybe you are not familiar with all the procedures that you may want to have or should have in place for better monitoring accounts receivable and your client’s performance.

So, here is why financial monitoring can be invaluable and the event that sparked this blog.  A friend of mine called the other day to just take a ‘look’ at a company’s financials and to help explain some things to look for when they reviewed the information. We started with using the company’s prior year performance along with their interim financials (balance sheet/income statements). Now, let’s take a look at the summary information: Sales, Margins, Operating Costs and their percentages of Sales. An example is provided below, which is completely arbitrary but gets the point across (I think).

Income Statement

FYE 2008

9/30/09 Interim

Revenues

25,000,000

14,000,000

Avg. Mo. Revenues

2,083,333

1,555,556

Gross Profit

7,500,000

3,000,000

Gross Profit %

30.00%

21.43%

Operating Expenses %

24.00%

25.00%

Net Income after Taxes

1,500,000

-500,000

What can be gleaned from this? The company’s sales have decreased, their margins are down and their operating expenses have pretty much stayed the same… one may want to ask what is going on? Did they lose a big customer? Is there a quality issue? Are their vendors charging them more? Why hasn’t the company also lowered their overhead expenses in relation to their declining revenues? Is the company seasonal? Some would just tell you, “It’s the economy stupid.” These are just some questions for which you may want to find out more, if you don’t already know the answers.

Now, let’s look at the factoring data. During those same periods, this factor had purchased $24mm during 2008 and $17mm through 9/30/09. (And, remember these numbers are not real but exaggerated for illustrative purposes only).

But, wait! Is that right? How could purchased invoices in 2009 exceed the company’s sales?

And, there it is… that ‘light bulb’ moment… need I continue… do I really need to write out what this means…

And, before you say anything, yes, there should have been other signs in the collateral, and yet, sometimes each one of those concerns could have been reasoned away, as they probably occurred gradually, in single occurrences, over time.

Moving on… you may also want to look at certain balance sheet information such as the Accounts Receivable balances. Does their A/R balance correspond to yours for that same time period? In the example above, probably not…

Just think, we haven’t even compared the company’s A/R turnover to the factor’s A/R turnover yet. Can you guess what that information would tell you? Well, to keep this short, we can save that for another time. Just understand that “pre-bill” may be in your future if these numbers are not consistent.

Without over explaining or making this any longer than it already is, I’ll end it here. The point, however, is that checking, reviewing and comparing company financials can be important. It is only an additional tool that factoring companies and lenders rely upon in mitigating risk. But, sometimes these tools can prove to be very telling.

Wishing You Continued Success. The Factor Guru.

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FAQs: Construction Receivables

Aug 22

Posted by Gen Merritt in Operations | No Comments

2ebf976ad673655aFactoring a construction business can pose additional risks. It is important to understand the billing processes and any potential subcontractor liens that may arise and interfere with payments on factored invoices. The discussion below provides some key items to consider, excluding bonded jobs.

The Underlying Agreement. Clients operating in the construction industry may have and typically do have contracts or master servicing agreements for each job being performed. These contracts typically include the work to be done; assignment language; contact information; billing protocols and requirements for payments; subcontractor payment and lien representations, insurance standards, and more…

Each contract should be reviewed, especially if the Client (for this example, a subcontractor on the job) is working on a longer term project wherein they bill monthly (generally on the 20th to 25th day of the month). Although the work has been performed for that month, the entire project has not been completed. So, yes, this would be progressive billing.

Hint: Jobs should be monitored individually, when possible, to follow when the job is completed and that the Client doesn’t invoice more than the contract amount without getting that overage approved in a change order, or in writing.  Especially when amounts billed are greater than the contract amount, change orders should exist. Additional billings that arise due to “verbal” change orders or agreements generally also come with payment problems attached.

Payment Requirements. Contracts may also dictate how the Client should bill invoices and may even include exhibits of specific forms to use for such billing (i.e., AIA forms for Certificate of Payments and Schedule of Values, etc). With these invoices, the Client may need to supply their customer (the Debtor) a release/lien waiver affirming that all subcontractors used on the project (hired by the Client to do work for them) have been paid.

Subcontractor Payments. Because of how the construction industry operates, another element to consider is where the Client stands in the payment chain; how far are they removed from the ultimate payor (the owner). And, how many other subcontractors have they (the Client) hired to do work for them?  Why does this matter? These subcontractors have rights to monies owed… their rights can supersede that of a factor or lender. They are not the same as suppliers on a manufacturing company’s payables listing.  Don’t think that just because you are funding a subcontractor that you are immune to these issues. Knowing that these subcontractors hired by your Client have been paid may be critical in the collection of receivables.

What happens if one of these subcontractors has not been paid? If a general contractor (the Debtor) hires the Client for a $100,000 contract to provide landscaping work and that Client then orders $20,000 of sod to be delivered to the job site, that sod supplier needs to be paid.  If the Client does not pay the supplier, the supplier may have the right to lien that job thereby affecting payments on that job from the Debtor to the Client.

This means that when the Debtor goes to pay the invoice, they may not do so right away, as they probably would have received a notice of the lien being or to be filed. So, first, that payment is at minimum going to be delayed. Secondly, the Debtor will more than likely make a payment of $20,000 to the supplier and then pay the rest of the monies to the Client (or the factor, as applicable).

This doesn’t sound too bad if the factoring company only has a 65% advance rate. However, what if the amounts owed to the subcontractor/supplier were 40% (or $40,000) and what if the factor had advanced 80% (or $80,000) to the Client. The factor would have advanced $80,000 to the Client and would only receive $60,000 back from the Debtor.

Know the Law. Each state is different but all tend to operate much the same in that if companies have performed work (labor) or delivered materials to or hauled materials from a job site, those companies are to be paid. There are various notice periods for filing liens and requirements to adhere to during this process. You can usually research your state’s lien and bond laws online, or contact your legal counsel for clarification. These differences will dictate notice periods and eligibility. They will also highlight your risks should you be factoring a Client in this industry.

As an example, a fourth tier sub may not have the right to lien a job whereas a second or third sub tier would.  In Texas, certain oilfield services industries may have up to 180 days to file a lien if payment has not occurred, whereas others may only have anywhere up to 90 days, depending on the type of job and where the Client stands in the payment chain. Again, each state may be different.

I know I can go on forever about liens, subcontractors and other nuances and examples within the construction industry… but this is a blog… not a book.

So, to wrap up, I’ll just list a few other items to watch for when factoring construction receivables:

Retainage: this is typically an amount held back (generally 5% to 10%) from each billing until the job has been completed. I mean the entire job… not just your Client’s portion. These amounts tend to take longer to pay or may not be paid depending on if other parties are owed monies, or if additional charges or fees need to be assessed. In some cases where subcontractors have not been paid during the job, these funds will be used to pay for those outstanding amounts. Because of this, many factors or lenders will not allow these invoices to be eligible for purchase.

Mobilization: billings for work ‘to be done’ on a project when no work has actually been done (yet). The Client may bill Mobilization to ‘mobilize’ their crews, purchase supplies, etc. If the factor advances on this type of invoice, it is important to understand that no work has actually been performed, some would argue this is much like purchase order financing. Look at the contract or call the Debtor to see if they will pay for such invoices in the event the project is put on hold or the work never starts.

Until the next time. Wishing You Success. The Factor Guru.

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Understanding the Billing

Aug 1

Posted by Gen Merritt in Operations, Sales and Marketing | No Comments

invoice-imageSince posting the FAQs: Transportation Qualification, I have received other industry specific questions, all of which seem to relate to understanding the paper being purchased. This got me thinking about the primary focus areas when reviewing invoices and their backup. Here are some questions you may want to ask yourself when looking at your documentation… or when discussing transactions with prospective clients…

How is the sale requested from the debtor?

In any industry, each party typically can evidence the ‘sale’ that generates an account receivable or invoice. Generally, a customer (Debtor) will ask the Prospect (Client) to perform a service or provide goods. This request can be in several formats such as verbally, a contract, work order, services agreement, purchase order, etc. This underlying agreement, when available (and yes, it’s available and does exist), dictates the terms of the sale. Pay special attention to those documents that refer to another agreement, the other side of the purchase order, or a website to print their underlying terms and conditions. You may find this information ‘enlightening’ when you are contemplating purchasing invoices and understanding the true sale arrangement.

How is the sale completed?

Once the service has been completed or the goods have been delivered, the Client can usually show that they did provide this service or deliver these goods. This can be in the form of a timesheet, delivery ticket, bill of lading, third party delivery, etc. There should be a way to show the completion of the sale, such as a sign off of the work completed, delivery documentation, etc…

When does a company invoice?invoices

It is at this point that an invoice is usually created and sent to the Debtor. Remember, the invoice is not what dictates the terms and conditions of a sale. It is a reminder of payment for the services or goods delivered. Understand too that just because the Client prints the invoice off their system does not mean a completed sale has occurred or that the customer will pay. For example, a Client may invoice when an order is shipped; however, the goods may need to be inspected (as per those terms and conditions you found on their website) before payment can occur.

What do I ask for then?

Many times, it is easier to ask the Client how they do their billing. What do they receive letting them know their customer wants to order something or have something done? What do they get when it is completed? What does their customer require for payment? Sometimes, it is better to ask these open ended questions to gain a better understanding of the Client’s overall billing process. For example, if you just ask for the purchase order, it may not include the original underlying contract that exists.

Many factors will request a sample of the Client’s billing during the due diligence phase. Often times, Clients tend to provide a sample that doesn’t match as they are just pulling the closest information they can find on their desk (meaning, you may receive a work order for one sale, an invoice for another and a delivery ticket for another). However, it is important to be able to review an entire sale from beginning to end. Try to have the Client provide you with an invoice and all the backup relating to that ONE entire sale or order.

Once you have a basic understanding of their sales process, new questions may arise as you review this paperwork. Understanding that paperwork is critical, so ask the Client whenever in doubt or whenever something is not clear… it is better to know before you fund an invoice than when you are trying to collect on that invoice.

It is also important to remember that each industry is different and may have various types of documentation specific to their industry. But, we’ll leave that discussion for another day…

Wishing You Continued Success. The Factor Guru.

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Missing Early Warning Signs May Be Hazardous To Your Business

May 15

Posted by Gen Merritt in Operations | No Comments

 

9f7d7e4213bb1a961Changes in a company’s performance or within their business may help identify Early Warning Signs before a potential problem occurs. Knowing what to watch for can help. Here are a few more signs and ‘changes’ you may want to be on the lookout for…

Management changes or high employee turnover exists: The question to ask is why? Are there other indicators within the company or the company performance? What is the succession plan and can the business operate effectively without that key employee or manager? What affect will their absence have on the business’s ability to provide you information? Is there a problem in the business itself that would cause management or good employees to leave? Will this change affect your collateral position?

Wiring instructions change: When a company becomes overdrawn on their account, garnishments occur, their bank begins paying down other bank debts from funds received, or other changes, the business may establish another banking relationship. Companies do not normally change their operating account without a good reason. And, I have experienced other cases where the company begins asking for checks to be issued instead of their traditional wires. Again, this is a change. Therefore, this could be a red flag as well; where is that money being deposited now anyhow? Do you get bank statements on a regular basis? Is the money staying in the business?

Payment patterns from customers (debtors) change: This may be a sign of credit deterioration in the debtor, pre-billing or overbilling by a Client, etc. When a customer has always paid their invoices at 40 days, there should be a reason that an invoice remains open at 75 days. Has the approval process changed, is there paperwork that is missing to authorize a release of that check, etc. Do you understand the debtors billing and ultimate payment process? Performing verification and collection calls on purchased invoices will help identify potential problems before they occur. One thing to remember: customers (debtors) do not typically change their payment patterns overnight.

Vendors start requiring shorter terms, cash on delivery, or post dated checks: When was the last time you received an updated accounts payable aging? When cash is running tight, companies may rely on their vendors for an additional source of working capital. However, at some point, this money trail could end. Vendors tend to have closer connections with the company and in their industry than you may have; Pay attention when those same vendors suspect financial distress within your Client. (Oh, and, start requesting and reviewing those payable listings if you are not already…).   

If you begin to see one of these situations occurring, this does not mean you need to over-react. However, you do need to act. Understanding the reasons behind these occurrences is essential. You can’t fix what you don’t know.

Identifying Early Warning Signs can help eliminate or mitigate potential losses before they occur. Dealing with concerns quickly can only help your collateral position as a factor. Should an issue exist, more than likely your Client’s business has already been impacted. Don’t let their problems also become hazardous to your business. Watch for Early Warning Signs.  

Wishing You Continued Success. The Factor 

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Early Warning Signs…

May 11

Posted by Gen Merritt in Operations | 1 Comment

e1bd96b3c40e992c1I realize this is out of the segment for my weblog… however, I believe this is a necessary topic to begin yet another subject: Early Warning Signs. Too many times, factoring companies come to the rescue too late. It is better to identify a problem before it actually becomes a problem. With that said, my first example: skipped invoices…

This one is tough if you don’t factor all of a company’s invoices. However, if you are factoring all of the invoices, then sometimes you need to take a closer look. Honestly, this is one of those little things that you may not pay attention to on a day to day basis. Many factors do not. It is something that seems extreme… after all, who can pay attention to everything, right?

Well, I don’t always myself. But, then you hear the story of a factor that purchased invoices wherein the debtor did not pay ultimately because of fraud that may have been recognized if the factor had first noticed the skipped invoices and those payments:

For example, a factoring company purchases invoices numbered ABC1 through ABC10; however, the company and the factor always had a long term relationship. They also had a long standing arrangement wherein the factor no longer called on all the invoices… they [the factor] had complacency in the relationship… the client account always worked well; therefore, why call on every invoice? Why call until the invoices reached the 75 day mark?

Along these lines, the next schedule included invoices ABC15 through ABC 18. Yes, some invoices had been skipped; but, again, everything on the account had worked well to date. The client account and their invoices had run well. The aging trends had deteriorated; but, the client relationship remained intact and encouraged waiting for the invoices to pay… no reason for collection calls to confirm the accuracy of the invoices based on the client history, right?

Unfortunately, the ‘real’ invoices were those with numbers from ABC11 through ABC14. Those invoices submitted prior were invoices submitted to the factor for funding only… they were not real invoices… the client had been submitting pre-billings… hoping for the work to be completed. Then, the client had invoiced for the actual work completed later.

Not only is that pre-billing, but the client had submitted invoices for funding in the second schedule for the work performed and advanced by the factor on the first schedule. Essentially, the factor had been double funding the work (i.e., funding the pre-bill and then funding the real bill). The factor just didn’t realize it because the real invoices were considered ‘non factored’ invoices and made up the difference… (If you are following this you may want to look at your client’s invoices and collections closer).

So, how do you know? Well, here are things to watch for:

-          The average pay days begin to slip; debtors do not change their payment history overnight unless a significant problem exists with that debtor’s capacity to pay. Watch for slower payments within the client and the debtor.

-          Dilution (non-cash reductions to receivables including credit memos, rebilling and billing errors, etc) increases wherein the client bills for work that has not been completed but then re-bills for work when it is ‘really’ completed.

-          The client is receiving the checks and redirecting them to the factoring lockbox… this can only been seen if the factor actually looks at the checks. Who are the checks being made out to and where are they [the checks] really being sent? Then, what do the remittance copies include? Do they match up to the invoices factored or are those checks missing the remittance (i.e., invoice numbers and amounts). Note: if you are only receiving the check image without the remittance advice, then how do you know how to apply the check accurately?

-          Trends within the client management of the account change (i.e, the client isn’t as responsive to your requests, etc).

-          The collections and the payments don’t match. Compare the payments received to those charged back, non-factored, etc as this may be telling. Do they balance? Did the non-factored money come into the lockbox? What happened to those invoices that were charged back? Did they ever actually pay? If not, why not? Do you know?

All in all, it’s about watching the collateral, looking for trends and anomalies, watching the turnover of the accounts (i.e., the DSO, collections to purchases, etc), ensuring what you purchased as a factor ties to the checks being written by the debtor, and ultimately knowing the client’s billing practices as well as the payment habits of their customers.

Knowing and recognizing these aspects helps to identify early warning signs within a portfolio… before a potential problem develops into a loss. Identifying and monitoring these concerns can ultimately help mitigate those losses, as well as provide examples to your factoring personnel of ‘things to watch for’ within a client base and portfolio. The potential of recovery is greater for those client accounts in which a factor remains proactive and aggressive. 

Again, early identification remains critical. Losses can be mitigated by seeing early warning signs wherein the collateral and performance may be deteriorating…

I could go on and on about this aspect; however, this is only one element that exists within the overall management of a client account. Ultimately, it remains a small detail of what to watch for within client performance compared to those other signs that are more commonly known. Hence, there will be more “Early Warning Signs” to come in future blogs…

Wishing You Success. The Factor Guru.

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Notification: Climate Critical

Apr 1

Posted by Gen Merritt in Operations | Comments off

Talking among some factoring companies the other day, I realized that many had differing views of the current credit market. I found it interesting that many of their perspectives stemmed from the condition of the factoring company itself: some factors were experiencing increased deal activity albeit with minimal increases in actual new business closed, others were targeting newly presented opportunities such as available acquisitions and others were focused on accessing capital to finance their clients (to be addressed in another weblog).

But then, there were those focused on problematic accounts. Actually, many factors were experiencing what I refer to as ‘challenge’ account situation, meaning both workouts and turnarounds.

In the current economic climate, however, many of these ‘challenged’ situations are now long term commitments for both parties: the client and the factor. Oddly, a lot of these more problematic accounts arose initially because the basic factoring fundamentals were not upheld… specifically notification. Because this is a building block within factoring, I have to say I was astounded at how many stories I had overheard pertaining to this specific issue.

Pursuant to Article Nine of the UCC (Uniform Commercial Code) factoring companies should incorporate a notice to the customers (debtors) of their Clients notifying them of the sale and assignment of the Client’s invoices to the factoring company. In reality, how else would those customers know where to pay or why they should pay you, the factor? This notice generally includes providing new remittance address information for where those debtors should pay invoices.

Side Note: Look at the checks that come through the lockbox. Are they mailed to the proper address or has the Client received them and then forwarded them to the lockbox address? This could be an indication that the debtor is not adhering to the notice.

I tend to recommend that any notices sent to a debtor should include ‘sold and assigned’ language in the notification letter; using a stamp or other legend on an invoice is also advisable; although some may consider this duplicative in meaning, it saves ambiguity (or confusion) for those customers.

Taking a stance of being more conservative? Protect yourself as a factor.

Operating under the K.I.S.S. principle? Send letters with proper notice, meaning stamp, label or include in the invoice template that language… why make it complicated? And of course, remember any advice pertaining to notification should be reviewed by legal counsel.

Now, many factors that purchase invoices send notice letters via overnight, certified or even fax delivery. There is a reason: Evidence. Not that it is necessary, but it helps. Think of when you, as a factor, need to prove that you did in fact send the notification letter, such as when a debtor states they never received the notice, didn’t know about the relationship with the factor, or states the Client instructed them otherwise of the factoring relationship, or maybe the debtor indicated the relationship had been terminated, or at least they were told such by the Client.

But, what happens when you send a letter to the customer and they still pay the Client at the Client’s address?

If you call the IFA or your legal counsel, they may direct you to use an ‘alternative’ letter to help protect your rights as a factor, or they may instruct you not to purchase future invoices for that customer. Remember, though, this decision may also be predicated on other general credit rules, including debtor concentration for that Client.

For example, if the customer is the sole customer for a Client, it is critical to ensure that customer pays the factor directly. However, if the customer represents five or ten percent or less, the factor may choose to send this type of ‘alternative’ letter to protect their (the factor’s) rights while still relying in some way on the Client’s reserves, all depending on the specific circumstances.

In any case, it is essential in a factoring operation to incorporate a notification process before, during and through a workout situation. Do you have these in place? Do you know?

These processes can sometimes become keys in managing the overall collectability of a Client relationship along with the exposure where situations arise that present an adverse condition between the factor and the Client. I can only implore you to evaluate these processes and the steps you take as a factor during each phase of a Client relationship. The current credit markets demand vigilance, as I always hear… and I couldn’t agree more.

Wishing you success. The Factor Guru.

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Factoring FAQs: Accrued Reserves

Mar 8

Posted by Gen Merritt in Operations | Comments off

This question actually came up twice this week. Because of that, I thought I would add to the Factoring FAQs illustrating Accrued Reserves.

The Accrued Reserve is just the portion that the factor didn’t advance to the client; it’s the amount the factoring company is holding back until the invoice pays, in the event their customer (the account debtor) short pays, disputes, discounts, or for whatever reason doesn’t pay the full amount of the invoice.

Accrued (sometimes referred to as Escrowed) Reserves are created when a factoring company purchases an invoice from their client. The invoice amount, less the initial discount fee (typically), less the amount advanced to the client is what then goes into the Accrued Reserve.

Once an invoice pays and the factoring company has received actual cash, this payment then pays back the factor for their advance, pays the factoring fees earned/accrued and creates what is called a cash reserve.

The below calculation and example assumes (i) an 80% advance (or purchase) rate, (ii) a 1.75% discount fee for the first 30 days from when the invoice was purchased by the factor, and (iii) the invoice paying in 30 days or within the initial 30-day period:

Invoice Amount Totals:  $263,500

Advance Rate 80%:  $210,800

Discount Fee 1.75%: $4,611

Wire Charge: $12

Advance less wire fee:  $210,788 (Amount that Client receives)

Ending Accrued Reserve: $48,089

Note the Accrued Reserve is the portion that is not advanced but being held back by the factoring company. When the invoice pays in full (assuming it pays in full), the Accrued Reserve would convert to a Cash Reserve and be returned to the client.  

The Accrued Reserve would decrease if the invoice paid after the 30-days, based on the additional fees charged by the factor, thereby reducing the Cash Reserve back to the client. The above example illustrates the invoices paying within 30 days only.

Wishing you success. The Factor Guru.

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