Factoring Companies Guidebook

The amount (or percentage) by which any debt (or Sales ledger as a whole) has or needs to be written down for the current account value to represent the amount collectable.

The level of dilutions is a Key Risk Indicator and the dilution levels should be regularly monitored.

Concerns

At any moment in time, an amount of the ledger against which we are advancing monies, can be subject to unknown dilutions rather than payment. In a "Gone Concern" situation, the level of unseen dilutions will affect the collectability of the ledger. It is virtually guaranteed that in such a situation, the Client will not be up to date with these items or will have deliberately withheld them, as it would have restricted the availability of funds. At the point of failure, we can expect to see the normal dilution level at least double, if not treble.

Identification

Review and analyse the historical sales ledger data looking for credit notes and journals. This may not represent the full level of dilution that would be seen in the event of a collect out, thus potential debt dilution should also be identified and reviewed.

The following form the main areas of debt dilution:

• Discounts
• Credit Notes

§ Defective Goods/Poor Service

§ Right of Return (see:-" Sale or Return/Exchange")

§ Goodwill (no legal right to return but the client accepts to preserve good customer relations and retain customer loyalty)

• "Retrospective Discount" (Volume/Turnover Allowances)
• "Advertising/Marketing Allowances" - Short Delivery - Non Delivery

§ Overcharges (through pricing and quantity error)

§ Credit and Re-invoice (where the Client corrects an error immediately) - Fraud (to remove 'fresh-air' invoices).

• Credit or Journal Adjustments

§ Bad Debts

§ Transfer between accounts

§ Write-offs (old balances or short payments) - Contras

§ Fraud (to remove 'fresh-air' invoices).

The credit notes themselves, together with the supporting documentation should be reviewed to ascertain the reason for issue. It is key to establish the timing of events here i.e. the date of original invoice, credit note and if applicable, subsequent re-invoice. It is prudent when carrying out any examination to address the month with the highest level of credit notes.

If the average value of credit notes assigned in a month declines markedly or none are assigned without a valid reason, a full review should be undertaken as it may be that the Client is withholding credit notes, to avoid reducing funding availability.

The Returned Goods procedures at the Client should be reviewed and the impact on the issuance of credits. However, dilutions can be hidden by the replacement of goods without issuing a credit note and new invoice. This can be checked through stock movement journals and by asking the Client its policy regarding this.

Enquiries should also be undertaken as to whether the Client holds a 'Credit Notes Pending', Disputes or Queries file. These would all be indicators of the potential dilution of the Discounters security.

Treatment

The level of prepayment could be reduced to allow for the anticipated dilution or a reserve introduced, maintaining our margin of security.

Similarly, if there are delays in the notification of dilution issues, where the level of credit notes yet to be issued is significant, a reserve should be set up or the pre payment reduced.

The reason for the dilution will affect the treatment. Where credits are raised and the amount is immediately re-invoiced the affect on security is minimal unless the sales ledger is being deliberately re-aged.