Risk assessment in credit and factoring transactions
Due to the phenomenon of payment gridlocks, the popularity of other tools is increasing – occurring in various forms of credit and factoring available in many varieties. The difference between them is that a third entity – Bank or Faktor – is introduced to business transactions on the line: seller – buyer. Its role is to assess, according to its guidelines, participants in this trading, transactions and related risk, based on which a decision is made regarding the possibility of obtaining financing in the form of credit or factoring. Due to the different nature of the credit and factoring transaction, the assessment made by the Bank or Faktor is also different, although it has the same task – providing financing to an economic entity.
Faktor versus Bank, i.e. what is important when assessing risk
During the assessment, the bank verifies the potential borrower in terms of creditworthiness, which is why the financial situation is taken into consideration above all and it is on this basis that the decision to grant a loan is made. Therefore, the credit transaction risk assessment is based on the borrower’s financial position. It is worth emphasizing that it does not concern the ability to repay credit obligations together with its costs in real time, but only the belief that in the future such repayment will be made. If, during the transaction, the bank loses this belief, the borrower may incur unpleasant consequences in this respect, e.g. he will be forced to additionally secure the loan, its amount will decrease, and as a last resort the entrepreneur will be faced with its full repayment, which usually implies serious financial problems, even leading to a loss of liquidity.
The factor while assessing the risk focuses on assessing the claims arising from the business transaction between the seller and the buyer. The repayment of the claim lies with the buyer, which is why he is the subject of the factor’s assessment. Although the seller will receive funds in exchange for the debt paid to the Factor, he is not the main subject of the assessment that determines the receipt of factoring financing. When assessing the transaction, Faktor also takes into account the debt portfolio, i.e. the number of recipients who should repay the debt. The risk assessment is then dispersed to all recipients, which means that the deterioration of the assessment of one recipient does not affect the assessment of the entire transaction. For the customer, this is important because the delay or lack of repayment from one recipient does not cause the seller to repay all the financing granted, which may occur in the case of credit.
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Different approach to financial statements
The basis for assessing creditworthiness are the company’s financial statements. In the assessment, Faktor and Bank focus on other elements of this document.
The starting point when issuing the assessment are sales revenues, also called turnover. Based on them, both the Bank and Faktor will decide on the size of the limit granted. Their significance in assessments is therefore similar. The difference may occur during the financing itself. In the case of generating lower revenues by an enterprise, the Bank may decide to lower the level of credit, and therefore the need to repay it partially or even completely. In the case of factoring, financing is reduced automatically – the smaller the turnover, the fewer invoices will be presented for purchase to Faktor. In such a situation, the enterprise will not be in a position of suspension of all or part of the financing.
For the Bank, one of the most important criteria in assessing a credit transaction is the company’s profitability. It is on its basis that cash flows, estimated as EBIT or EBITDA, are estimated to be the source of credit service. Bad profitability assessment, both at the application stage and during the credit transaction, usually results in negative consequences for the company. For Factor, which bases its financing on the purchased debt, profitability assessment is not significant, therefore it is not crucial for making a decision to suspend financing.
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Financial liquidity understood in a different way
Financial liquidity is treated in banking assessments as covering current liabilities with current assets (inventory, receivables, cash). On a specific day, the Bank checks whether current assets are able to repay at least liabilities payable in the short term. The higher the value of current assets compared to the value of short-term liabilities, the safer the situation is from the Bank’s point of view. If the value of short-term liabilities, including revolving loans, is higher than the value of current assets, the Bank recognizes the risk of no source of repayment of working capital. This formula for assessing liquidity has little to do with the liquidity of the enterprise itself. Rather, it is closer to the solvency of the enterprise, i.e. the situation when the enterprise lost liquidity. In turn, liquidity, in the factor’s opinion, is related to the rotation of receivables with the seller and the rotation of liabilities with recipients, i.e. periods in which cash flows from, for example, sale purchase transactions, from which he acquired the receivable, will occur. Therefore, the actual financial stream is assessed. At the same time, due to the dispersed portfolio of recipients, the repayment source, and thus also the risk is also dispersed.