Issues with Invoice Concentration
Invoice concentration refers to the dollar amount of invoices payable by a specific account debtor (customer) a factor purchases. Invoice concentration represents a risk the factor must manage and it can be better understood through the following examples.
Single Client Concentrations
Single client concentration occurs when a factoring client does a large portion of it’s business with a single customer. For example, a commercial cleaning service that does 80% of its business with a single casino. This puts the factor at risk (whether recourse or non recourse) if the casino should file for bankruptcy since with 80% of the factors advances and invoice purchases are dependent upon a single source of payment, the remaining 20% of advances with other account debtors cannot possible make up for the losses experienced form the 80% investment in a bankrupt debtor.
Multiple Client Concentrations
Multiple client concentrations occur when a factors has more than one client providing services for a single customer. For example, a factor might have 10 or more service providers such as guard companies, janitorial companies, staffing companies, etc. that all provide services to one large account debtor such as an airline, big box store. Although failure of the big box store and the non-payment of their invoices may not cause any of the clients to fail, the overall loss to the factor who has a significant amount of exposure can be devastating.
Managed by the Factor’s Accounting Software
Concentration is a problem that is managed by the factor’s accounting software which constantly monitors exposure to account debtors. A factor may, for example, never want any single account debtor to comprise more than 1% of it’s invoice portfolio thus limiting the effect of an account debtor bankruptcy. To do this, factors may periodically refuse to purchase specific invoices from a client due to their effect on portfolio concentration.
Credit Insurance Limitations
Many factors employ “credit insurance” to protect against extraordinary losses in their portfolios. With a credit insurance policy, an insurance company may insure against the bankruptcy and/or nonpayment of an account debtor upon purchased invoices due insolvency. Typically, such policies are “Master Policies” and a rider is put in place for each new account debtor added. The credit insurer will place a “maximum purchase amount” or cap on purchases for a covered account debtor. Should the factor purchase an amount of invoices exceeding the cap, it is at risk for any losses on those uninsured invoices.
How Concentration Can Affect Your New Client Submissions
Brokers should be aware that prospective client submissions for factoring can be declined if an unusually large portion of invoices are the result of supply goods and/or services to a single account debtor. If the account debtor representing the concentration is large and creditworthy, it will usually not affect the success of the submission. If the account debtor is not a strong credit, however, the factor will often limit the total dollar amount of invoices it will purchase so as not to expose itself to undue risk.