It is essential that both factors and discounters assess the credit worthiness of major debtors. Generally speaking factors/discounters will not assess debtor creditworthiness unless the debtor exceeds a certain percentage of the client ledger, or if the balance outstanding is a large sum. The exact guidelines will be set by each factor/discounter, and may differ for a factoring facility as compared to a discounting facility.
If the purchase percentage in a factoring or discounting arrangement is 80%, then the retention percentage would be 20%. If any single debtor comprised 20% of the ledger and there was a problem in collecting the balance due by that debtor, then the factor/discounter would have to collect all the other remaining balances to recover their advance. It follows, therefore, that any debtor exceeding the retention percentage should be carefully assessed for their creditworthiness. Many factors/discounters undertake this assessment at levels lower than the retention percentage e.g. 10% or even 5%.
In setting credit limits, the following should be taken into account.
- concentration %
- trade references
- credit agency reports (such as Dun & Bradstreet, Baycorp Advantage)
- customer payment history with the client
- how long customer has been trading
- financial statements, if available.