There are a number of reasons that financial documentation is required when applying for accounts receivable factoring or an asset based loan.
1. Firstly the factor needs to verify that their client is going to remain in business. The trend of sales, expenses and income are all telltale evidence of a client’s stability and reliability.
Unfortunately if a client who is the supplier on the other side goes out of business the customer / debtor may not pay for the goods. As an example, if the factor’s client is a furniture manufacturer and the debtor is The Big Store, The Big Store will always have a number of suppliers.
Using the Balance Sheet can be a valuable lesson in common sense when predicting whether a client will stay in business or close down soon. For instance a low figure shown for the client’s AP (Accounts Payable) would ring an alarm bell because that could mean suppliers are not supplying goods. That may mean the client’s credit worthiness is so bad that they may be paying cash for their goods.
If one supplier goes out of business, a debtor/customer may decide that they will not pay for the last delivery. This is due to the customer having incurred additional costs. They may even be embarrassed by having the goods displayed in their catalogue with no continuity of supply or warranty fulfillment.
Balance Sheets which are not prepared on time may indicate that the accountant is not working for the client and that may mean the client has not liquidity to pay the accountant. All this does not auger well.
2. The factor needs to compare the amount owed to CRA as shown in the application and compare that to the liability described in the client’s Balance Sheet. If there is a discrepancy, the factor will expect a good explanation as to why the 2 amounts differ.
If the client owes money to Revenue Canada, the factor can call CRA with the intention of negotiating a settlement with CRA on behalf of the client. CRA is often “relaxed” and reasonable because they realize that with new money coming in from the factor, they will get paid faster. And without that money coming in, they may never get paid and the client may go under.
3. The third reason is that if the client shows any degree of bad faith at the beginning of the relationship, the factor may decide not to proceed and may refuse to fund the deal. A factor reserves his right to change heart and refuse to fund right up to the 11th hour.
This may seem harsh to the client, but from years of experience, the factor has learnt to do all his due diligence as thoroughly as possible.
All the above require the client to submit transparent and accurate figures. Any factor would much prefer a client to be honest and admit to some weakness or imperfection and the sooner the client explains that challenge to the factor, the better.