Why do some deals make it and others don’t, even when they have similar characteristics? Even when you go through the company background, the receivable base and performance, financial trends and sometimes the background and credit of the guarantor, in some cases, a prospect may not fit into your box. Why?
Well, this can be attributed to just a deal that doesn’t fit within a factoring company’s target client profile. It may, however, be perfect for another factoring company based upon their niche, risk profile, or other criteria.
One other reason may be because too many holes exist. What does this mean?
Someone (I believe it was Michael Haddad, Core Business Credit) told me once that when you mitigate too many risks in a transaction… it’s like a block of Swiss cheese. There are too many holes without enough cheese holding it all together. I know… sounds weird but the analogy stuck.
Since factoring is more of an art, I think this Swiss cheese theory helps explain why.
So, what are the holes? Many look at the six Cs of credit when reviewing a prospective client transaction. I tend to break it down to four key areas instead (as I can never remember the other two as everyone seems to have a different other two): Character, Collateral, and Credit, along with Common Sense of course.
You may ask why Character first? The person running the business who has the relationship with the customers can be critical when reviewing a new transaction. How they manage their personal finances may be indicative of how they manage their business and, ultimately, how they may work with their factor or lender during challenging financial times.
Collateral remains the foundation of factoring. Some important questions to think about: Who does the company sell to (what types of customers)? How is the customer credit? What type of industry does the company operate in and what current trends are ongoing in that industry that may affect the collateral? Do concentrations exist? What does the aging reflect about aged invoices or credits? How does the company bill? When is an invoice considered accepted by the company’s customers?
The third element, Credit, can include customer credit; however, what about the credit of the company? What do their financial statements show? What is going on in the business? What is their margin and does it support the factoring expense? Are there any entries or trends that require additional explanation? Remember, reviewing one period of time only provides a snapshot; however, having prior financial statements to compare against may help show trends in the business.
Finally, Common Sense is a must. This is the key element that brings all the other pieces together. Does the information reviewed correspond to the discussions held to date? Are there any areas that remain unclear or are conflicting with the information reviewed? Have the holes been mitigated in a way that would result in a successful collection, should the need arise? Is there enough cheese… or, are there too many holes?
Wishing you success. The Factor Guru