A factoring company assesses a new client in two parts. First it checks the client, their records and any claim others have on their invoices. Then it checks the debtors, the customers who will pay those invoices. Most of the work is in the debtor ledger, because the debtors are the real source of repayment.
The client
Start with the business that wants the cash.
- The company: it exists, it trades and the owners are known. The KYB guide shows how.
- Records: can they produce a clean sales ledger, aged by invoice date?
- Other claims: has a bank or lender taken a charge over the debts? In the UK, the charges register at Companies House shows this. A bank that holds the debts as security must release them, or agree who ranks first.
- Tax: unpaid payroll tax or VAT can rank ahead of some lenders if the client fails. So ask for proof that the client is up to date or on a plan.
- The contract with each debtor: does it ban the client from handing over the invoice? The law on this differs by country, so ask your lawyer.
The debtor ledger
The ledger is a list of the invoices that are open, who owes them and how old they are. Check the total against the sales ledger in the accounts and the latest VAT return. The totals will not match exactly, but a big gap needs an answer.
Then read the ledger in three ways.
Look at age first, since old invoices are the first sign of a problem. Many factors set an age limit, such as 90 days from the invoice date. Some also treat a whole debtor as unfundable when a large share of that debtor's balance is old. The share is a choice for your policy.
Next is concentration. Work out how much of the ledger each debtor owes. If one debtor is a third of it, the client's risk is really that debtor's risk. Most factors set a limit for each debtor.
Last is dilution, which is money that never arrives because of credit notes, discounts, returns and disputes. Add up the credit notes for the last year and divide by sales. A high figure means the cash the client gets is less than the face value of the invoices.
Also look for debtors that you should not fund. These often include companies in the same group as the client and the owners themselves. They also include customers who are also suppliers. A customer who is also a supplier can cancel an invoice by setting off what the client owes them.
How to verify invoices
An invoice on a ledger is a claim. You need to turn it into a fact.
Ask for a sample of invoices with the proof behind them. That means the order, the contract and the delivery note. Contact the debtor and ask them to confirm the invoice, the amount and the due date. Check that the invoice numbers run in order and that the dates fit the delivery. Look at the client's bank statements and find the payments from the debtors. Real invoices turn into real payments.
Verification does not stop on day one. Repeat it as new invoices come in.
What to ask for
- An aged debtor list, dated this week.
- The last two years of accounts and the latest management accounts.
- Twelve months of sales by customer, and a list of credit notes.
- The latest bank statements.
- The contracts with the largest debtors.
- A list of the client's debts and any security it has given.
- Proof that tax and payroll are up to date.
Red flags
- A debtor with the same address, phone or owner as the client.
- Sales that jump just before the application.
- Invoices for round amounts, or with gaps in the numbers.
- Debtors who do not show up as payers in the client's bank statements.
- A client who asks debtors to pay into an account that was not agreed.
- A debtor who will not confirm an invoice.
- High credit notes in the weeks after a funding date.
A worked example
This is an example with made-up numbers and an assumed policy. It is not a real client.
A client has a ledger of £484,300. Debtor A owes £171,200, which is about 35% of the ledger. Debtor B owes £96,900, about 20%. Debtor C owes £64,700, and £41,500 of that is over 90 days old. The rest is spread across smaller debtors.
The policy says a debtor is unfundable if over half its balance is past 90 days. It also says the advance is 80% of what is fundable. Debtor C is 64% overdue, so all £64,700 comes out. The fundable ledger is £419,600, and the advance is £335,680.
The credit notes in the last year are £38,600 on sales of £2,310,000, which is about 1.7%. That is low enough to note and move on. But Debtor A at 35% is worth a hard look. The credit team decides on a limit for A. It also decides whether to confirm A's invoices before the first advance.
What can and cannot be automated
Software is good at the reading and the sums. It can read the debtor list and the accounts. It can total the ledger and compare it with the accounts. It can age the invoices and work out concentration and dilution. It can also apply your policy to find the fundable balance. It can look up the client and the debtors on the company register. It can also ask the client for the missing paper while they are still there.
A person still has to decide how far to trust the client. A person also decides if a big debtor is strong enough, and if the checks with debtors were good enough. Those are credit calls.
Klarefi is the intake step. It reads the application, the debtor list and the statements. It asks for what is missing and links each number to where it came from. It does not set limits or approve the client.
Try the debtor list check on a ledger. Our page on factoring shows where intake fits.