Well, I am still new to this blogging concept… this week we did have some other topics on risk prevention, not just risk management. In some cases, this may not be the new deals you are looking at, but rather, those already on your books. The common theme among some of the questions: payment application on invoices. And, you ask, why does this even matter?
When invoices are funded from a schedule that has been submitted, several implications may be made. First, the factor is maintaining their books, the receivables, to monitor those invoices. Second, the company selling the invoices may rely on the factor (depending if the factor offers these services and if the company selling the invoices desires these services) to enter the invoices, call and collect on the invoices, and track payments accordingly. Overall, payment application should be a simple concept: When a payment comes in on an invoice that has been factored, the payment should be applied to that invoice.
Sometimes, however, companies will call and request that a factor use payments that come into a lockbox to close out other, older invoices in an effort to reduce accruing fees or for other reasons, even when such payment request would mean applying collections from one customer to another customer’s invoice(s), applying collections for one invoice to other invoices, etc. In other cases, no check remittance may be available and instructions for how to apply such funds are directed by the company (not the customer writing the check). And, although rare, potential frauds can grow over time should misapplied payment practices be in effect.
Logically, reducing fees makes sense if that is the reasoning behind such request. The majority of the time, however, other underlying factors exist. Applying payments to the wrong invoices can cause confusion among the parties involved, may result in invoices appearing to have been paid that in fact have not, or may show skewed account debtor payment history on the factor’s reporting system. More importantly, it may make it harder to reconcile both the company’s and the factor’s records at a later date, should the need arise.
By applying payments to proper invoices, or showing them as non-factored funds if they are truly non-factored, the paper and payment trail can be maintained. Should a company want to use those funds to reduce fees, they may be able to just use the available ‘cash’ reserves to close out invoices. This maintains the integrity of the payment history for all parties involved, including the account debtor (the company’s customer). This process also allows for collection calls to be placed on aging invoices that may still be open with the company.
So, how do you know if this is a problem? Just do a simple audit. Pull a few months of collections or even a sample of a few customers/debtors (meaning, actual check images/copies) and compare these checks to how those payments were actually applied. Do they match? Were they applied to the right account debtor and the correct invoice(s)?
Now, what do you do if this type of payment practice has already started on a client account? Sometimes, the best rule may just be to correct the problem going forward. And, sometimes, once caught, you may be able to identify a potential risk that may not have been known. You may be able to prevent misapplied payments that had been a cover for fraudulent activities on behalf of a company selling invoices to a factor. Again, this would be an exception. However, good processes and practices cannot only help a factoring company but also the company selling the invoices.
Wishing you success… the Factor Guru.