Invoice factoring accounts for hundreds of billions of dollars in transactions each year. Although many business owners aren't aware that they can receive instant working capital by monetizing their accounts receivable through factoring, it is commonly used as an alternative to traditional bank loans.  Unfortunately, there are unscrupulous and desperate individuals who try to manipulate and defraud factoring companies to enhance their firm's cash position.

The overall process of factoring is relatively simple. The client issues an invoice to a customer for goods sold or services rendered. The customer has accepted the goods or services and promises to pay on account within the client's credit terms. Instead of waiting for 30 to 60 days to get paid by the customer, the client submits the invoice to the factoring company and receives an advance based on a percentage of the invoice. This percentage is anywhere from 70% to 90%, depending on several factors such as type of industry, creditworthiness of the customers and length of time in business. The advance is immediately wired to the client's account. The customer mails a payment payable to the company to a lockbox controlled by the factoring company. The factoring company then remits the reserve (the invoice total less the amount that was advanced) minus the factoring fee. The transaction is now closed. If all the factoring situations went like this, there would be no problem. But when fraud and manipulation come into play, it changes everything.

The most common way dishonest people defraud a factoring company is by submitting a false or inflated invoice for advances. Usually, this is done after the relationship has been in place for a while and the factoring company has developed a comfort level, especially with particular debtors. These phony invoices can be done very easily with a modern software and a cheap printer. They can be done with existing debtors that the factoring company recognizes or fictitious customers. Usually, the phony invoice is submitted along with several legitimate ones and the funds are collected.

Since the funds will never be "collected", wouldn't the factoring company ask for the client to refund the money or replace it with another invoice? Ordinarily that would be the case, but the fraud is typically perpetuated by the customer submitting another fake invoice for advance and using those funds to pay the first one. That fraudulent invoice is paid for with the proceeds of phony invoice number 3. In essence, the client is floating an interest free loan until perpetuity or until they are caught.

Most factoring companies that stay in business for any length of time will put a system in place that will detect such fraudulent occurrences before it can spin out of control. Verification is the cornerstone of this system. This includes not just the verification of invoice amounts and legitimacy, but also making sure the initial information given about each of the debtors is valid. Because the factor has such tremendous exposure, they must control payments by requiring debtors make all payments to a lockbox. They must verify information provided about debtors by independent sources, not just by the client.

The relationship between the factoring company and the client should be cordial, yet entirely professional. An example of how a business relationship became too personal was when a client began dating a staff member of the factoring company. He learned from his new girlfriend that the factoring company only verified invoices greater than $800. With that information, he suddenly flooded the factoring company with several phony invoices between $600 to $700 each. By the time the owners of the factor caught on, their exposure was over $100 thousand dollars. They probably could have sued the client, but knew that to do so would put the client out of business, which would cause economic peril for themselves. They had no choice but to ride it out and hope things would turn out okay.

Most people are honest, but it only takes one or two bad apples to place a factoring company in a precarious situation. That's why verification on an ongoing basis is critical for a factoring company to function.