Factor in fraud when selling customer invoices

If your business struggles to generate steady cash flow from operations, factoring is a possible solution. With factoring, a business sells the right to collect on customer invoices to a factoring company in exchange for an immediate payment.

If you have slow-paying customers, factoring accelerates the collections process. But some companies abuse factoring and use it to commit fraud. 

The basics

There are two forms of invoice factoring. With recourse factoring, the business selling invoices agrees to repay the factor the advance it received (a percentage of the invoice’s face value, minus a fee) if a customer doesn’t pay the full amount. Non-recourse factoring is less common because it involves more risk for the factor. The business doesn’t have to repay the factor if a customer becomes insolvent during the 90-day period following sale of the invoice.

In either case, the invoice seller must provide the factor with certain customer information. Typically, this includes:

• A copy of the invoice,
• The customer’s contact information,
• The customer’s payment history, and
• Details about contracts governing the relationship.

Factors might ask for additional documents, including information about your company, to aid their verification process.

Fraud steps in

A shady business owner — or even a rogue accounting employee — could commit fraud by submitting illegitimate customer information to a factor. For example, an invoice might name a fake customer and list an invented email address or phone number the fraud perpetrator controls. Or the customer may be legitimate, but the invoice amount is inflated.

Invoices don’t have to be fake — at least not at first. A crook could initially sell legitimate invoices that are highly collectible. Then when the factor agrees to purchase more, the fraud perpetrator could start selling doctored invoices. In one Florida case, dishonest employees were caught selling the same real invoices to two factors — and collecting double payments.

Internal controls help

Preventing factoring fraud starts with an ethical culture and strong internal controls. Make sure your accounting staffers and managers understand when it’s appropriate to engage a factoring firm to monetize receivables. Establish procedures, including a formal authorization process, that everyone must follow.

To ferret out factoring fraud that’s already occurring, scrutinize receivables balances. If they fluctuate significantly or there’s a high incidence of early payment, investigate further. To detect unexplained cash infusions, ensure that bank accounts are reconciled daily and that the employee reconciling accounts isn’t also involved in recording payments.

If you suspect factoring fraud, contact us for help investigating.