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.

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 

Who said factoring was like gambling? Lately, now that I have been playing poker, I wanted to examine this concept… or misperception. Many people seem to say this ‘gambling’ comment flippantly only because of a perception that they believe exist. However, sometimes, you have to delve deeper… to find the truth. After all, perception is reality… right?

No. Not always, if you choose to look hard enough. So, let’s go with my basic assumption of Texas Hold ‘Em. After all, I am from Texas.  

The first rule: the one with the most bank has the best chance of winning. Do you have enough capital to play the game for the long run? Factoring is not a game you get in with limited capital. Don’t take it lightly. Real money is at stake. You have to have sufficient funds to play the game. One loss cannot dictate your endurance in running a finance company. Putting “all your eggs in one basket” may help you grow; however, can you survive the loss? If you experience losses, are you still in the game? And, will a large fraud break your bank?

If so, factoring is not the business for you… when you are new to the game. This mainly applies to those who do not do their homework, who do not understand that vigilance in underwriting and monitoring deals remains a key aspect to the factoring business. No one can teach you how to start a factoring company without also explaining the risks. It’s about your people, processes, systems… and more. Just think, all that is before you start.

You also have to understand the risks, how to mitigate those risks and how to monitor those risks over time. When you set out to start your factoring business, capital is essential… But, keeping your capital is critical. It’s not just about putting the money out there; it’s really about getting the money back!  Funny that in poker, it’s not about the risks, it’s really about getting your return (and your money back). Hmmm…

The next rule: Do you know the cards you have been dealt? Are you really looking at what’s in your hand, or are you just chasing the cards you think you have? For example, what do you offer relating to your corporate ‘tiers’ such as People, Processes, and Systems? These tiers are your strengths. Know your tiers. Know your strengths. Play to those cards. Within this,

First, know your people. Can the personnel you have handle the type of clients you are seeking? Can they handle the type of account management required for those specific accounts? Do those personnel truly understand the dynamics of various industries in which you may want to branch out into to diversity your portfolio?

Second, know your processes. Setting up procedures within your company can be essential. Think about those unique situations that require governmental regulations (i.e., Assignment of Claims, CAGE codes, etc), monitoring transportation carrier payments, or even subcontractor payments (i.e., lien releases, etc.). If the processes you have in place do not include this type of account management, then those processes are insufficient to effectively manage those types of client accounts.  

Finally, know your systems. Do you have the proper software to effectively monitor certain types of accounts? This also may include transportation, construction, or other types of processes and reporting that are being done manually within your company. Technology options exist that help monitor certain industries and assist in improving your systems to better manage your client accounts effectively.  

If you don’t know these basic tiers about your business as a factor, then how can you know what you can do? How do you even know how to read your cards? Again, if you don’t understand these fundamentals of your factoring business, you will experience challenges in managing your portfolio, let alone expanding or diversifying. Know how to read the cards you have been dealt.

With all of that said, I’ll save the next rules for another blog. But, good luck! Remember, know your capital. Know your cards.

Wishing you success in your game. The Factor Guru.

It also brought about something else: help others, acknowledge those that are learning and work to help them succeed. Several people, industry veterans as I would call them, always went above and beyond, out of their way, and more to help me learn more. I was lucky, I guess.

For this weblog posting, a friend of mine and one of my mentors, Darla Auchinachie, a 17-year veteran in the factoring industry and a long time speaker, board member and advisor for the IFA, agreed to write an article. To maintain this trend of helping others in the industry and showing her continued dedication to the industry, she has shared an article with us that rings true… for factors, clients and others. Pay attention. I always did.

This is an open letter to every factoring company executive. 

                Unless you’ve been stranded on an island the past year, you probably haven’t been able to escape the news concerning the biggest economic crisis to hit since most of us embarked in the career of factoring.  As we enter the new year the media claims we just can’t wait to get this behind us.  But wait, the factoring community simply can’t go along as business as usual expecting to avoid being impacted by the crisis merely because a new year is upon us. 

                It’s time to take a serious look in house and be prepared to engage in some strategic planning to take your company through these incredibly challenging times.  I spoke to a trusted friend recently, his comments keep ringing through my ears.  He says, “Its bananas out here”.  Yep, that sums the economic crisis up, especially to the all the factoring companies, bananas just bananas. 

                The economy is shrinking, but wait it’s the perfect storm for us – banks will get out of our space, we’ll be flooded with opportunities is one point of view.  Another says yeah, but credit is our biggest concern right now, and it should be retailers, the auto industry, the oil companies in our account debtor base, the bankruptcies are sure to start stacking up come the first few months of the year.  Yet others are concerned for their own liquidity and access to capital. 

                Bananas, heck we have a whole fruit salad. 

                I call on every factoring company to consider taking action on a few items which will see them through the murky times ahead.  Look, no one knows what’s going to happen; we truly are in un-chartered territory, most fear to make predictions, some believe that we will be on our way to recovery by the end of 2009, and yet others are planning how to best benefit through it all. 

                How can you benefit when you can’t even be sure which way the economy will turn or how long this recession will last?  Well, you can’t control the future but you can be informed and prepared, lest you are blindsided by any number of salvos which will surely come your way. 

                They are saying that we are entering into a period of economic Darwinism.  That is to say, only the strong are going to survive.  For example, Wal-Mart will no doubt end up stronger because of the smaller retailers who will fail due to the downturn of the economy.  Here are five steps a factoring company can undertake to make sure they live to factor another day.

#1

                Re-underwrite every client in your portfolio.

                Yes, now is the time to know what you have, the good, the bad and the ugly.  Trust me; every portfolio has some ugly in it.  There is no better time than now.  Sure, most factoring company’s resources are already stretched beyond the limits due to the influx of new business, but if you don’t stop to take a look at what you already have, you will be in for some trouble.

                While the economy had been growing by leaps and bounds and credit had been so readily available, every factor benefited; we took on clients whose risk profile was higher than we would like to admit.  We cannot bury our head in the sand anymore.  You have to know what portion of your portfolio is performing and which portion will become plagued by the recession.

                If you do not have current financial information on your clients, now is the time to request it.  If you don’t have a recent UCC search, why not run a new one?  When was the last time you engaged in a background check on existing clients?  It’s time to look beyond historical dilution and trends, instead it’s time to take a reading on the client’s overall financial health as that is the indicator which will foretell their ability to survive. 

#2

                Re-structure Relationships

                When you find those clients most negatively impacted or the clients whose financial risk profile has changed, you must seriously consider altering the structure of that relationship.  For example, you may have taken a secured position on a piece of commercial real estate as secondary collateral to support a factoring relationship whose risk profile was not in line with your traditional limits.  What is the value of that real estate now?  What is the financial health of the client now? 

                If revenues are down, how is that affecting the business?  What can you really do when you are already in a relationship?  Make sure you are utilizing every collateral monitoring and availability tool in the book.  Don’t let invoices age; don’t take on unnecessary credit risk.  Counsel your clients on being very careful about extending credit terms to marginal customers.  Start building additional reserves if necessary.

                Reduce your exposure whenever possible.  Make sure your client’s maintain some skin in the game.  Consumers are walking away from the value in their homes because they just can’t make ends meet.  What decisions will your client have to make with their business?  How does that impact your existing A/R?

#3

                Get your house in order and have a contingency plan.

                Since we don’t know what surprises are on the horizon for the next 12 months, it might also be a good idea to keep your books and records in manageable order.  Whether you have $500,000 of your own funds employed or you work for a company who has $200 million employed, there is a very real possibility in 2009 that a factoring company’s access to additional capital will be slim to none.

                Be prepared for an audit either from your capital provider(s) or from which you are seeking capital.  The better your files are, the better your audit results will be.  It doesn’t hurt to triple check that your documentation is in order, proper names, trade names, and all that.  By the way, when was the last time you checked to see if a client was still operating under good standing status in their state, update everything in your files!

                Factoring companies may find it hard to raise capital in the form of subordinated debt; others may find that their institutional funding has dried up.  Worse still, your lender could exit the business abruptly.  Have you taken the time to review your portfolio and operations to make sure it remains attractive to capital providers?

                Seek out assistance within the industry or outside of the industry, but do something and have a plan in place should something like this occur.  If you make it past 2009 and the economy heads upwards you may breath a sigh of relief – until then, how prepared are you?

#4

                Keep employees educated and motivated.

                Factoring is such a unique business, there is a human element deeply engrained in this profession.  Make sure the folks on the ground know how to sniff out problems.  Account Executives shouldn’t let a week go by without having some contact with the principals of your clients.

                Stay involved in providing continuing education to every member of your team.  Let them know that the playing field has changed out there.  It’s not all about proper verification and notification anymore.  Your team should be looking out for different kinds of stresses such as signs of employee theft as well as pre-billing, over billing, and the like. 

#5

                Don’t be afraid to take action. 

                Sometimes, as a factor we are faced with making unpopular choices, especially when it comes to calling a client in default and entering into a realization phase.  Now is not the time to use hope as means to operate, it is the time to deal with facts.  Clients who do not have the ability to cash flow even with the factor’s funding may simply be too big a risk to continue servicing. 

The other day, someone sent me samples of backup documentation to review for a new prospect. The client (a transportation carrier) had been with another factor prior and was still being financed by that factor. The good news, however, was that the potential new factoring company wanted to make sure they understood the ‘paper’ they were buying… before they actually bought it. They had questions. They didn’t want to assume. So, they asked.

As it would turn out, the paperwork for the invoices (i.e., invoice, rate confirmation and the bill of lading) indicated other carriers that had hauled the load, or they revealed loads were picked up… but not yet delivered. Strange I thought. However, during the initial verifications on the invoices, the calls with customers of the carrier (or account debtors) evidenced that the loads were real; however, the goods were still en route. What do you know? Would this be an incident of pre-billing?

More than likely… yes. Here’s the question though. What does this mean to the current factor? The only thing I could come up with that happens all the time: complacency. You know what I mean. That thing that happens over time when you become comfortable with a client relationship, you stop looking at all their paperwork, you don’t call as often on their invoices as you used to, etc. Complacency does happen.

Now is the time to look at those clients’ performance, and more importantly, to review the account management on those accounts — to review the processes and procedures in your portfolio. Typically, factors feel they know the ‘weaknesses’ in their portfolio already. They ‘watch’ those accounts ongoing. Yet, it is the client you know and love that sometimes has issues… causing financial challenges… and potential exposure and risk to the factor.

The current economic climate dictates vigilance. It requires relentless review of your portfolio. It doesn’t stop there: looking more at the invoices and backup documentation being reviewed, how the collection calls are going and how checks are coming into the lockbox can be critical. In this new financial environment, a good check and balance system should be in place, even an internal audit each quarter or a few times each year. Otherwise, how will you feel comfortable that your processes and procedures in place are being adhered to sufficiently?

How will you know complacency is not occurring? Several firms perform these services including Factor Source, Factor Help, and several other examination and auditing firms. Or, call the International Factoring Association for consultation and assistance. You can even have someone internally review these processes. This is not a sales opportunity but a mantra for looking at your portfolio… over and over and over again. I believe it was Keith Reid who said, “If you think fraud isn’t in your portfolio, then you just haven’t looked hard enough.”

Yes, these internal exercises may appear to be in vain and actually may result in nothing being found. (What a relief). And, yet, if you identify a potential concern before it transcends into a true problem… then, it is worth it, right?

Vigilance is the test for a factor. Yes, trust, by verify; however, maintain vigilance. Reduce complacency. Focus on not just sending money out the door but also getting the money back.