Age Disapprovals
Many things in life improve with age - a good wine, for example. When it comes to invoices, it's not quite the same story. Businesses send to their customers invoices with pre-agreed payment terms, e.g. 30 days from invoice date. What this means is there are 30 days free credit for the customer to pay for the good or services received. This concept gives us the "invoice due date" - the date the invoice is due to be paid. Some customers pay promptly, but unfortunately, many "drag their feet" and pay the invoice well beyond the agreed period. This doesn’t mean they will never pay. It doesn't mean that they cannot afford to pay. They may just be exerting their "buying power" to get more free credit.
When it comes to factoring, the overarching principle is that advances made to the client against invoices will be repaid by the debtors (the client's customer). With a recourse agreement, the risk of non-payment stays with the client. Generally, there is a reassignment period, e.g. 90 days following due date, when the factoring company has the right to assign the invoice back to the client.
Many factoring companies exercise this right of reassignment immediately when the invoice hits the reassignment date. Of course, the assumption here is that the client is financially strong enough to absorb the potential bad debt that may arise if the invoice is completely no collectable, for example, if the debtor goes bust (becomes insolvent, to use a more professional term). With recourse factoring, if a debtor goes bust it's the client's problem, but if the client goes bust, it is the factoring company's problem.
Many factoring companies apply the logic that it is better to retain the overdue invoice, even though it could be reassigned, so that they have a chance of collecting the money from either the debtor or the client. Two is better than one!
This is where the logic of age disapprovals comes in. The disapproval of an invoice means it cannot be financed and effectively creates a reserve. But surely the invoice was already financed weeks earlier when it was first submitted by the client. This is true, but disapproving the invoice now means that the factoring company will effectively withhold funding against new (hopefully collectable) invoices that the client will submit going forward. The magic of the availability formula takes care of this for us.
Article written by Kevin Day