Commercial Factoring: Are Clients Receiving All the Money to Which They Are Entitled?

{6:40 minutes to read} 

Factoring, a form of commercial lending, typically offers two types of services to its clients: a degree of credit protection and providing the company with the ability to borrow against its assigned receivables.

Factoring is especially prevalent in industries involving the manufacture and sale of consumer goods, such as the garment, furniture, and shoe industries. Companies in these industries are often faced with the need to raise money in order to finance their operations and to produce the following year’s line of products before the current year’s products have sold.

As for the degree of credit protection that can be provided by a factor, the company submits its purchase orders to the factor. If the factor approves the purchase order, the factor bears the risk of loss in the event that the customer is financially unable to pay the invoice. For example, if a department store goes bankrupt, it is the factor that bears the risk of loss with respect to the invoices associated with the approved purchase orders.

With respect to borrowing, all accounts receivable that pertain to approved purchase orders for which the company has invoiced its customers are assigned to the factor. The bonus for the company is that it is permitted to borrow an amount equal to a certain percentage of its assigned receivables, often up to 85%. This means that if, for example, a company has assigned $1 million of receivables to its factor, it would effectively have a credit line of approximately $850,000 to draw upon — the funds it may need to design and produce the following year’s line.

When entering into a factoring relationship, companies oftentimes will accept the contract proffered by the factor and attempt to negotiate, if at all, only the commission and interest rate, without consulting with an attorney knowledgeable about factoring. However, not all factors, and not all factoring agreements, are the same. There may be charges that are not apparent to the company and other provisions affecting when the client is credited with payments received by the factors from the company’s customers, which can impact substantially the amount of interest the company is paying its factor and, accordingly, the cost of factoring.

After entering into the factoring relationship, the company’s three main concerns are to determine if:

  1. interest and other charges are in accordance with the terms of the factoring agreement;
  2. it is receiving credit for all payments that are received by the factor from its customers; and
  3. it is receiving credit for those payments on a timely basis.

If the company is not getting credit for all payments that the factor receives, or if it is not getting credited on a timely basis, then the company is not receiving money to which it is entitled. If a company has a loan balance – which many, if not most, companies will – then payments received from a company’s customers will reduce the amount of the loan balance and, therefore, the amount of interest being paid by the company. If payments are not credited to the company’s account, or if they are not credited in a timely manner, the company will be paying excess interest, oftentimes without even knowing it.

The company is dependent upon the factor to collect receivables, to timely and properly apply the payments it receives, and to accurately and clearly account to the company.

Contending with an overwhelming amount of documentation and transactions, a company’s financial department – particularly a small company with limited resources – may encounter difficulty tracking payments made to and from the factor, when they are received, or how they are applied. Even more difficult for the company may be tracking payments made by its customers to the factor which, for various reasons, may not have been applied to the invoice for which the payment was intended – the great mystery of “unapplied cash.”

Nevertheless, companies must  monitor their account statements. In most cases, factors put an “account stated” provision into their contracts, providing, in substance, that if a company does not object in writing to an account statement within 30 days, they cannot thereafter challenge the accuracy of that statement, even if it is wrong. These provisions have had mixed success holding up in court. Oftentimes, their application will turn on the accuracy, transparency, and completeness of the information provided to the company by the factor (from the information provided by the factor, did the company have sufficient information to meaningfully assess the accuracy of a monthly statement?), as well as the vigilance with which the company reviewed its accounts and monitored its factoring relationship.

 Since factoring contracts and the documentation provided by factors are often confusing, companies should speak with an attorney well versed in factoring. That attorney can work with the company’s financial department or accountant, or with an analyst with special expertise, to help the company determine whether the charges they are incurring comport with the terms of the contract and whether the information it is receiving from the factor is complete and accurate.

When it works well, factoring can be the financial lifeblood of a company. When it works poorly – if the company is being taken advantage of – it can be the death knell of a company.



Share This Content