Debtor approval is the step in which a factor decides whether it will buy invoices owed by a particular customer. Approval is often granted with a credit limit that caps how much of that customer's debt the factor will hold at one time.
How it works in factoring
Because the factor will be repaid by the customer, it assesses that customer much like a lender assesses a borrower. Typical inputs include:
- Commercial credit reports and payment history from business credit bureaus
- The factor's own experience with the customer, if any
- Public records such as liens, judgments and bankruptcy filings
- The customer's size, industry and length of time in business
- Financial statements for large exposures
Approval can be for a single invoice, a fixed credit line, or a standing approval that is checked periodically. Factors may approve a customer for a lower amount than requested, or decline new invoices if the customer's payment pattern worsens.
For non-recourse factoring, debtor approval is especially important, because credit protection usually applies only to approved customers and only within the approved limit.
What to check
- Ask the factor to check major customers before you sign, so you know which invoices will be funded
- Learn how you will be notified if a customer's approval changes
- Understand what happens to invoices above the approved limit
Running credit on new customers before extending terms, a step many factors will do for you, also protects your business beyond the factoring relationship.