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.

Yes, factoring does go back over 4,000 years to the Mesopotamian King Hammurabi. He was the ruler who established the world’s first metropolis, Babylon, considered the bed of civilization. The Mesopotamians are accredited with being the first to implement notes/borrowings on clay tablets between two parties. These clay ‘contracts’ indicated promises to pay; they were promises for future payments. This concept expanded trade and increased economic power for that time, setting a foundation for certain alternative forms of finance today.

Since then, factoring has evolved becoming a critical financial tool for doing business in almost every civilization that followed, the Romans included, who were the first to sell discounted promissory notes. The first documented form of factoring in the American colonies, however, was prior to the revolution.

Merchant bankers in Europe gave the American colonists advances for materials, allowing the colonists the ability to harvest their lands. Raw materials like cotton, furs, tobacco and timber were shipped from the colonies to Europe. Factors during these colonial times advanced against the accounts receivable of these companies. This practice became very beneficial to the colonists, as they didn’t have to wait for the money to begin their harvesting again.

Later, during the economic revolution, factoring became more concentrated on the issue of credit, as factors began assuring payment for certain clients (today known more as non-recourse factoring). Before expanding to varied business types after the war, factoring specifically catered to the textile and garment industries in the United States.

By the 1960s and 1970s, an escalation of interest rates and tighter credit spawned a new interest in the factoring market, with a number of private factoring companies coming into existence. By the 1980s, further rate increases combined with new regulations within the banking industry caused many small businesses to seek alternative sources of funding outside of traditional banking. It was at this time, factoring became a more popular option for many of these companies.

As many of you know, factors make funds available even where banks cannot often do so; typically, factoring companies focus on the creditworthiness of the customer (debtor). In contrast, the fundamental emphasis in a bank lending relationship is on the creditworthiness of the company itself, not that of its customers.

Factoring is a financial transaction wherein a company sells its invoices/accounts receivable to a factor at a discount. In exchange for this, the company receives immediate working capital. Three parties are involved in the transaction: the factor, the company seeking financing and their customer (the account debtor). The sale of the accounts receivable transfers ownership of those invoices to the factor, at which time the factor obtains the right to receive the payments made by the customers.

Today’s factoring still focuses on advancing funds to small to mid-size, rapidly growing companies who sell to larger, creditworthy customers. Factoring is among one of the most effective and efficient forms of financing utilized by businesses. It immediately improves the cash flow of a business.

In addition, today’s factor offers other support services for their clients including providing credit checks on new and existing customers, sending monthly statements to customers for payment, performing collection calls, processing and maintaining history on invoices and customer payments, and providing reporting for this information, typically with online access for the client. Some factors even provide additional financing services for their client companies.

After all of that, the only history question from Factoring Jeopardy that this actually addressed and answered: Who is Hammurabi? I no longer remember the other questions… maybe some of you do and want to comment…

Wishing you success. The Factor Guru.

The hibernation of hedge funds, private equity interests and investors is ending as they become hungry for stronger returns.  However, coming from a strategy where this community pretty much shut down their money flow altogether—they now want very high returns in exchange for cash and credit lines.

Meanwhile, commercial banks have turned off their lending spigots for small business because of the volatile credit conditions, and the aggressive enforcement oversight by government regulators who prohibit these lenders from any perceived questionable transactions.

At this time, the credit line needs of factors should be one of the best income-earning risks which banks can entertain.  Unfortunately, many bankers have a mind-set:  They do not lend to finance companies.

When their questions and concerns about this issue are examined, their reasons are often distorted and lacking in fact.  Many commercial bankers ask:  “Why should our bank give a credit line to a finance company, when we would not make the small business loans being made by the finance company, ourselves?”  They argue that the loans often made by the finance company are to “unbankable” business entities.  These companies are not strong enough, not old enough, with a problematic track record and worse.

We are not lending solely on historical balance sheets.  We are lending mainly based upon collateral which we manage on a daily basis (while most banks only look at financial statements on an annual basis). We also look at a company’s future business based on their orders in the pipeline.

Commercial banks and factors need to find common ground to reach prosperity together.  When driving a car, do you spend most of your attention looking in the rear view mirror, looking at where you have been?  Or, do you stay focused on the windshield and watch where you are going as you move forward?

If those “unbankable” small businesses have valued collateral, which we as factors and asset-based lenders can control—we are able to provide them money to help these businesses grow.

The lending marketplace has room for both the commercial bank along with factors and asset-based lenders.  If a business owner has a strong balance sheet, they are going to seek out a bank because it is cheaper and less work to submit occasional financial statements.  If a business owner is undercapitalized yet their company offers a lot of potential, and they want to take advantage of every opportunity which comes along—asset-based lending and factoring is very appropriate.

So long as banks conduct their usual due diligence, they will find that extending credit lines to finance companies is a good quality risk, many times better than their regular lending standards.  Most times these loans are diversified, spread out, over different industries, different geographic areas, different customers, different payment schedules, so the finance company is not dependent on any one particular loan, the risk is much less than they would find in one regular business.

Furthermore, the people running these finance companies are often very experienced, very professional in the depth and knowledge of the industries they are financing.  They are executives the banks can “talk to” as opposed to many businesses where an owner’s lack of understanding breeds a strained, perhaps, negative relationship.

Another silver lining, for banks giving credit lines to factors and asset-based lenders, is the potential of a finance company to provide mutual referrals.  As a business becomes more stable where it progresses into a more attractive prospect for a traditional bank, now the factor or asset-based lender is in an advantageous position to hand off their client to a bank of its choice.  There will be strong influence in that decision by the finance company which has helped the business owner.

There are only a small handful of banks which have recognized the vista of lending to finance companies. They have benefited from these relationships for many years.

About the Author:

BY NEVILLE GRUSD, C.P.A., EXECUTIVE VICE PRESIDENT, MERCHANT FACTORS CORPORATION (WWW.MERCHANTFACTORS.COM) WITH OFFICES IN NEW YORK CITY AND LOS ANGELES.  MR. GRUSD IS A DIRECTOR AND ACTIVE MEMBER OF THE EXECUTIVE COMMITTEE OF THE COMMERCIAL FINANCE ASSOCIATION (CFA).  HE IS A MEMBER OF THE EDITORIAL BOARD FOR THE C.P.A. JOURNAL, THE OFFICIAL PUBLICATION OF THE NEW YORK STATE SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS.

And yet, CIT’s other business segments combined with other nonbank, unregulated, newsworthy companies that failed in 2008 and 2009 have shed new light on something referred to as “Shadow Banking,” which many believe is to blame for the recent economic crisis.  What began by general comments during a speech in 2008 has evolved into a full out mission.

Unfortunately, this new light may ultimately and indirectly impact the factoring and asset based lending (ABL) communities at large, which would also adversely affect small businesses.

How so? As early as February 2010, rumblings in the marketplace have noted that staffers may begin preparing new legislation in the regulatory reform bill, which is intended to regulate the Shadow Banking segment. Some believe, including the American Factoring Association, an advocacy arm of the IFA, that both factoring and ABL companies could be inadvertently bundled under the category of Shadow Banking.

Note, however, that the majority of these factoring/ABL companies are nonbank, unregulated financial institutions that provide ongoing working capital to small businesses. These are predominantly independent financial institutions. Their sole purpose is to provide capital to companies that simply do not qualify for traditional bank lending; they do not engage in the trading of derivatives or collateralized debt obligations. They do devote their energies towards accurately valuing the most liquid assets of a business such as receivables and inventory.  Funding is not provided based upon past financial performance, time in business, or even future earnings or performance of a business. This alternative form of finance is very different, while often misunderstood.

In the January 8, 2010 publication for The Deal, one article noted final legislation should be made public near “the end of 2010 for 2012 implementation. This means uncertainty will prevail for the bulk, if not all, of next year.” This article focused on mortgage securitization and other forms of finance, however, and not specifically Shadow Banking. With that said, many of the items addressed may also be included in the next legislative bill.

What are possible inclusions for this new bill? For one, possible tightened capital requirements for banks that finance factors and/or ABLs, thereby potentially limiting financing resources, or raising the cost of financing for factors and ABLs. In the article mentioned in The Deal, one possibility would be not just to tighten capital requirements but to assess standards for “fixed capital requirements for various types of risk-weighted assets.” Knowing that many of the companies using factoring and ABL services are not considered bankable, what would their risk weighting be considered?

Moreover, the ramifications of this heightened awareness and legislation has the potential to greatly impact small businesses by then shutting off working capital to these companies that is now so readily available through such forms of alternative finance. The result for many small business owners: fewer available financing options… and that is just the beginning…

There are some finance companies who believe this type of legislation may never occur, or that this regulation would have little impact on their business. There appear to be more who believe that this regulation needs to be addressed now, as the effects of such regulatory reform and legislation would dramatically impact their individual business, as well as the factoring/ABL industries and small businesses alike. As Adam Smith said, “…by pursuing [our] own interest [we] frequently promote[s] that of the society more effectually…”

The AFA has already identified a lobbying firm in Washington, D.C. to not only create a preemptive effort for the benefit of the factoring and ABL communities but to also increase awareness on how critical our segment of the commercial finance industry is for the U.S. economy as a whole. If you have questions on this potential legislation or to find out what you can do to help, contact the American Factoring Association at (805) 773.0021 or visit their website at www.AmericanFactoring.org.

Wishing us all continued success. The Factor Guru.

BY RICHARD EITELBERG, CPA, FOUNDER-PRESIDENT OF HARTSKO FINANCIAL SERVICES, LLC, A SEVEN-YEAR-OLD PURCHASE ORDER FINANCE FIRM WHICH HANDLES ABOUT $150M IN ANNUAL TRANSACTIONS, BASED IN BAYSIDE, NEW YORK (WWW.HARTSKO.COM)

“The Great Recession” has left a lot of asset-based lenders and factors weak and lame.  Their inability during this period to access credit lines from banks, hedge funds, and equity investors often means they must restrict money to existing customers or refuse prospective clients.

Purchase Order Financing and Letters Of Credit generally looked upon as a last-resort bitter pill have seen increased acceptance as a way for a business owner to preserve a transaction opportunity.  With up front honesty, PF is expensive because of the very high risk issues involved and the intensive servicing requirements.  However, if a deal has the potential to yield a 30% profit or more—why should the business owner be concerned about sacrificing a few more percentage points over and above a traditional lender?  Is losing the opportunity to do the deal altogether, a better alternative?

Factors and asset-based lenders should realize that if they are at the end of their line with their client, referring the PF route can keep their relationship and income opportunity alive.  PF is a fast way for their client to secure funds needed to fulfill customer purchase orders and expand their business without giving up equity or trying to borrow additional funds (an option which no longer exists).

Here’s the process:

1.   The customer submits a purchase order to the client with all documents

2.   The client submits the customer purchase order to the PO financier for approval with all costs associated with transactions

3.   The PO financier will then will make direct payments to the client’s vendors so that the merchandise for the customer PO can be produced

4.   The client’s vendors deliver final product directly to the end customer or to a third party warehouse until shipped to end customer

5.   The seller then invoices the shipment and sends invoice and corresponding copy of customer PO to the factor

6.   The factor funds the invoice at his discount, paying the PO financier their loan plus fee

7.   The factor (or bank) collects from the end customer and pays the client their residual left from the advance

PF is taking a piece of equity in a client’s deal on a temporary basis, perhaps, thirty, sixty, ninety days, or 120 days.  A PF firm earns a fee on a precise part of the deal.  The PF firm doesn’t really “lend” a business money.  Most times, PF firms do not actually give a business any money or hard cash.  The PF firm’s money and equity backs up and supports the integrity of said purchase order.  It makes transactions work by opening up an LC usually overseas to procure merchandise, products, and materials for businesses.  (Or, wires are sent to domestic manufacturers to make purchases in behalf of businesses.)

PF is only transactional and temporary with the money going to fund the goods or merchandise in that specific transaction.  PF funds are not allocated to fund payroll, rents, cars, or any other business operations. Therefore, PF enables start-up companies to grow and troubled companies to survive.  Even bankrupt companies are generally able to access PF because the fees are guaranteed by the court.

Finally, in terms of the relationship, PF firms are not offended that a business owner may use this process one day, while returning to the factor or traditional lender the next day.  The PF community recognizes that PF is only going to be used when it is absolutely necessary and all other lender options have been exhausted.  The PF firm accepts that business owners and their lenders will only use it when they need it!

For more information on purchase order financing, feel free to visit www.Hartsko.com, or contact the IFA directly.

More about the author.

Richard Eitelberg is the Founder, President of Hartsko Financial Services, LLC., with offices in Bayside, New York and Deerfield, Illinois.  Mr. Eitelberg, was graduated from Michigan State University with a BA in Accounting.  He earned his license in certified public accounting (New York State).

Mr. Eitelberg has been the Chief Financial Officer for two garment industry companies: Adrian Landau Designs, and B. Lucid.  He was a Senior Auditor for Josephson, Luxemborg & Kantz, CPA’s, PC. He began Hartsko about seven years ago, assembling a group of private equity investors.  Today, Hartsko handles purchase order financing and letters of credit with some $150m in annual outstandings. (www.hartsko.com)

Mr. Eitelberg, a resident of Plainview, New York is a member of the Commercial Finance Association, the International Factoring Association (preferred vendor) and the Turnaround Management Association.

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).

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.

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?

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.

As a follow up to the Part I weblog from May, here are some other pokerisms (if that is even a word – probably not) that may be useful in your journey as  a factor… or they may just be entertaining. Either works.

Don’t be a “fish,” otherwise defined as a bad poker player. These fish never truly understand how to play the game; they just keep playing. In  factoring, if you fund enough bad deals or make too many exceptions to the rules that result in losses, you will eventually lose… you may even lose your  business. Good factors know the rules of the game, develop them, and execute them every day. If you are not sure where to seek assistance on the rules,  attend an IFA seminar or call the IFA, an industry consultant or even a friendly competitor for help.

Don’t throw good money after bad… sometimes, when you have a problem account, you may believe you need to continue providing working capital to the company so they stay in business. After all, if you are short on collateral, how else will you get your money back? This decision is not to be taken lightly. You cannot hope your way out of a deal that has gone bad, as they say.

Do your homework. What is really going on in the client’s business? How can it be corrected? Take your time to identify your exposure and other repayment or collateral options. Understand the inter-workings and financials of the business itself. Will putting more money into the pot really help get your money back?

Learn from your mistakes… it happens. We can all become complacent in our monitoring protocols with long time clients. We make exceptions to get deals done quickly, or we believe we have covered all of our bases (i.e., seen all the options on the river) during our due diligence… only to find we missed something extremely important (or misread our cards).

However, we can only get better if we actually learn from those mistakes. Go through your history of losses. Make a list and refer back to it. What were the reasons those losses occurred? What were the exceptions, if any, you made to get the deal done? What were the common characteristics between the various transactions? What have you learned from looking at this list?

What’s that song? “…Know when to fold ‘em. Know when to walk away. Know when to run…“

Did you see the July weblog “Understanding the Story… What If,” a guest blog by Darla Auchinachie? Once in awhile, there is a voice tapping you on the shoulder saying, “Um, perhaps it’s time to leave.” And, sometimes when you listen to this voice, you live to play another day.

One bad call in judgment can destroy ten good calls. How many deals does it take to make up for a loss on one bad deal? Do the math…

At some point, you will lose. You really can’t win them all. Some elements are out of your control. Structuring deals appropriately up front will however help mitigate losses significantly. Ask yourself on every transaction you review, “Can I get out tomorrow?” If not, why not? What can be done differently should you need to collect out of the deal?

Being aggressive can be a good thing. When a deal goes awry, it is better to act and act quickly. In factoring, the entire client receivable base can turn over in 45 days. The longer you wait, the further you may be from your collateral. And, don’t forget that the longer an invoice stays open, the harder it is to collect.

Good luck. Wishing You Success in the Game. The Factor Guru.

Trend Cards, however, can help identify Red Flags as a whole and can provide a tool in monitoring accounts. Most Trend Cards include a 12-month period reflected on a monthly basis showing aging trends, dilution, receivable turnover, or other data points you want to measure. These reports can be manually generated in Excel or Access; some factoring software systems may include automated reporting for this information as well.

When reviewing trends, it is important to watch for anomalies. Below are some key data points you may want to monitor more readily:

PURCHASES. For example, monthly Purchases may illustrate sudden increases or decreases in sales, which may be attributed to seasonality or even a loss of customers because of quality issues. Where sales are suddenly increasing, this may be because of recent large orders or possibly even falsification of invoices. If a Client has no Purchases during a month, this could be a Red Flag.

COLLECTIONS. Changes in Collections can signify other Red Flags. You may want to ask yourself: Are there concerns within the verification or collection calls lately? Are all the checks going to your lockbox? Are customers paying more slowly? Is this a sign of potential pre-billing? Look for consistency in the relationship between Purchases and Collections. No Collections in the last month or erratic relationships between the Purchases and Collections could be a Red Flag.

DILUTION. Dilution changes should be monitored as well. Dilution results from the non-cash deductions to receivables. This is any time an invoice is not paid in full at par (face) value; therefore, reserves are applied for discounts, short pays, charge backs, credits, and other non-cash entries. Material increases in Dilution should be addressed.

Changes in dilution may represent a change in the Client’s business or billing practices. Are more invoices being charged off, disputed, or collected by the Client directly? Has the Client grown too quickly or not been on top of billing and collections as tightly? These are questions you may want to get answered.

It is important to note that typically an advance rate is initially set based on the expected Dilution. If over time, a Client’s advance rate stays at 80% but their Dilution increases to 25%, then for a $1,000 invoice, the advance to the Client would be $800 but only $750 would be paid by their customer.

THE AGING. The aging allows you to see how a Client’s typical receivables are spread over time. Watching for anomalies in this spread is important, as an early detection method or as a note to start monitoring a Client more closely.

As you can see, trends are a historical perspective only; however, when reviewed as a whole, these trends may reveal inconsistencies that may need to be addressed. For additional information on this subject, please feel free to email me, or call the International Factoring Association for additional reference contacts.

Wishing you success. The Factor Guru.

Changes 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