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Factoring or risk insurance, are they useful?

The world of corporate finance has many strategies, concepts, and methods of making money and running smoothly. Some are more effective than others, and some aren’t effective at all. Yet they are still used. Some of these practices include factoring and risk insurance. In some rare cases these practices can be useful. But more often than not they are a temporary fix for a problem. They only create more expenses for your company.

Let’s be more specific by explaining what these two practices really are.

We’ll begin with factoring. This is when a company sells its accounts receivables to a financing company to receive a percentage of their value in cash. You receive immediate capital, but overall less money than you would have if you haven’t gone down this road. It’s as if you had a car you could sell for 10,000$, but because you needed the money right away, you sold it for only 7,000$. Long story short, you are trading away your valuables for less than they are worth and essentially cheating yourself out of money.

Beyond that, factoring has many other disadvantages. Customers that were paying for those accounts receivables will be notified when factoring takes place. It warns them about your cash flow troubles and may create some amount of stigma, assuming that your company is going downhill financially. And of course, besides not making as much money from the accounts receivables as you could have in the first place, factoring them is still more expensive than most loans. The financing company you sell the accounts receivables to often charge prime rate interest on cash advances. It creates a total of large amounts of annual interest that could be crippling for your business.

As for risk insurance, it is simply insurance offered to high risk individuals that are more likely to need that insurance than others. For obvious reasons, this is something with very high potential to be painfully expensive.

On one hand you are receiving more money by offering insurance to a wider range of customers. But on the other hand, you are drastically increasing your chances of having to pay significant amounts of money for some sort of accident. Take auto insurance as an example. Imagine that you offer insurance to an individual that has crashed their car 4 times in the past five years. That individual is paying you an insurance premium. But what is the likelihood that you will be paying for yet another crash anytime soon?

In that sense, risk insurance is fairly simple, and it’s fairly simple to see why it is a bad idea.

Of course, some would say that making such assumptions is foolish. Just because that driver has crashed so many times in the past does not necessarily mean he will again. And this is true. Probability is nothing more than a hypothesis really, and one that can’t even be proven until the incident actually happens. That said, the majority of corporate finance operates on predictions. The stock market itself operates almost completely on predictions and guesses. Avoiding high risk situations is just a way for companies to stay safe, and avoid putting themselves in a complicated situation without suitable payoff.

And as we all know, the idea behind insurance is to provide it to individuals who will need it the least. Insurance companies receive a lot of money from their clients, but as soon as that insurance actually becomes needed, they are suddenly losing big bucks. This system of operation may not be necessarily fair, but it is certainly the most financially sustainable. It’s just like lending. You lend money to individuals you are fairly certain will pay it back. It’s just good business practice.

Of course, it’s important to understand that every financial strategy has some merit. If not, no one would have used them in the first place. As mentioned previously, business factoring can be useful in the sense that it provides immediate capital in an emergency. But in the long run, it is the only advantage it offers. And in every other way, it is a hindrance. It’s important to acknowledge that just because a course of action has benefits does not mean it has an overall benefit for your company.

That said, it is up to each individual company to determine whether or not certain courses of action are right for them. Even if those decisions aren’t the best for everyone.

Best Practice #2: Always Improve

If there’s one thing that’s true about the efficiency of business no matter what aspect of it you are discussing, it’s the fact that more efficiency in the workplace makes the entire system operate more smoothly, and usually at less cost too. The same can be said of the collection process, which is why you should be constantly seeking to improve both the system and the efficacy of your employees in achieving their objectives.

There are several ways to go about this, but knowing which improvements need to be made requires thorough analysis of the collection process. Maybe the team needs to be more efficient, or maybe the policy itself needs to be altered. Perhaps it would be best to let the entire process be handled by a collection agency? It all depends on what shortcomings you discover during the analysis of your company’s collection process.

Because the collection process is exhaustive in both time and resources, it’s important to estimate which option will actually be less costly for your company in the long run: hiring the services of a specialized collection agency or formulating your own internal collections division. Neither option is necessarily superior to the other, as they both have advantages and disadvantages. For instance, outsourcing the collection process to a collection agency means you don’t have to train your own employees to perform the same task, which consumes time and resources. On the other hand, collection agencies don’t care for the customer relationship, instead doing what they have to do to guarantee that the debt is collected. This can make it very hard to retain clients in these situations.

On the other hand, making your own internal collections unit also has pros and cons. Employees for your own company will be far more invested in ensuring a client stays with the company even after a collection, but on the other hand the internal unit will likely be more expensive, if only because of the cost of the specialized training they’ll need as well as the cost of supervision and management of a new branch within the company.

If you settle on an internal collections unit, there are many ways to improve their performance, chief among them choosing the optimal employees to fill particular roles in the process. You should also consider employee incentives, something that will motivate the unit as a whole to work towards more desirable results in the collection process. Everyone likes to be rewarded for a job well done, so imposing a reward for that work is fairly good practice.

In the end, different options work best for different companies. Some may find that enlisting the services of a specialized agency is the most practical choice, while other companies may find that organizing an internal collections unit serves their purpose best. Determining which one will serve your company most efficiently is simply a matter of careful analysis of your preexisting collections process or lack thereof, which makes the final decision obvious.

Best Practice #3: Quality Information

When it comes to a process as delicate as collecting money, nothing is going to make that process more frustrating than having inaccurate information in regards to it. Everyone would like the collection process to do its job as quickly and efficiently as possible, and that means not wasting any time on situations that weren’t necessary because someone passed along incorrect information. Precise and organized knowledge is the key to making the entire process as quick and simple as it can possibly be.

In order to achieve this organized information, you’ll need to have a specific system to both facilitate and organize it efficiently. Unorganized knowledge does nothing to lessen the complexity of the process. This system of organization will often have information divided into three sections of reports: management, monitoring, and risk management.

Management reports will deal with lists primarily, detailing past due clients that still need to be visited or contacted by a collections agent, or organizing past due clients by the length of their delinquency or the scale of their debt. These reports are critical for keeping track of clients in a way that determines which ones need to be dealt with first and foremost. For that reason management reports will usually be generated daily to keep the staff updated on what still needs to be done and how urgently those actions are required.

Monitoring reports deal more with portfolio than anything else. These reports will often determine delinquent portfolio based on many different factors, including ratios of efficiency on the collection process, delinquent portfolio by product, and summaries of portfolio by ageing and zone. Generated weekly or maybe even monthly, these reports will generally be used by upper management to address issues with delinquent portfolio performance.

Risk management reports exist to better predict the outcome of different factors in the process, and to allow oversight for the performance of the whole process. Information regarding the impact of collections over portfolio performance through tracking indicators, recovered balances, billing cycles and individual roll down ratios are all included in risk management reports.

Outside of these reports, you will also want to ensure that your basic client information is always accurate. When the time comes to act on a collection, you’ll need to be able to locate and contact the client as quickly and easily as possible, and that means staying up to date with all of their contact information on a fairly regular basis. The ease with which you can physically locate them and contact them is important.

Finally, you’ll want to invest in numerous internal committees and units to gather such information and act on it as necessary. All information needs management, and that can be most easily achieved through the formulation of internal methodological control units and internal past due committees. The greater level of management you have within the collection process, the more accurate and organized the information you need to use will be, and the more efficient and simple the whole process can become.

Best Practice #4: Well-Defined Collection Strategies

For a system that you will have to fall back on several times over the course of your business career, your need to have tried and true but more importantly clear cut and solid strategies and policies in place for everyone to follow. Policies and strategies such as this exist for the sole purpose of directing your employees’ actions under certain circumstances and guiding them on how to respond when things change. Having a good plan is critical to the overall success of the unit, even if that plan has to sometimes be altered on the fly or not used at all.

The first and most important policy to formulate for your collections team is how they are to initially contact past due clients. There are so many ways to go about it, there needs to be a guide that determines which tactic is most effective and when. Should the team contact them through phone, email, or a written letter, and how many days past due should first contact be? Moreover, you’ll need to lay out the rest of the procedure as well, such as how and when second and final contacts should be carried out. This is one of the most important strategies to formulate and clearly define for your team.

You will also need to set up policies for the handling of risk based collections. A lot of things can happen during the process that affect how it needs to be handled. Sometimes the client has suffered personal tragedy, and in that case your agents may need to approach them differently. You may also encounter issues with client excuses, clients unable to be contacted, and other problems and obstacles that you can’t expect to be part of the normal process for a collections officer. You need to lay out strategies and policies for your employees to use when these obstacles arise, in order to handle the situation as efficiently as possible.

You’ll probably also want to use a strategy that divides your clients into segments. Knowing your customer segments is a critical aspect of running any business, and it is exactly so for collections as well. Having different types of clients divided into groups that match the criteria you have set will make it easier to predict how they will be dealt with whenever particular situations arise. What criteria you use is completely up to you, but the most common criteria are location, solvency, ability to pay and attitude.

In the end, these defined strategies and policies will never be one hundred percent full proof. They will often need to be altered on the fly as situations change, but that doesn’t negate the useful nature of having a plan in the first place. Whether or not a plan is used it is always prudent to have one in place as the default method of reaction to obstacles and issues. How you go about establishing those strategies and policies is key to their success.

Jordi Pedrol : “Support growth by developing the right infrastructures”

We interview CEOs and CFOs about growth and the infrastructures needed to support it. Today, we interview Jordi Pedrol, part-time CFO for several startups and companies. 

Can you tell us about your experience?

I’ve been working in Finance for 30 years. I worked in the Tech industry in Silicon Valley in the late 90s’, during the first wave of the Internet.
I moved to Spain and I work as part-time Chief Financial Officer since 2008. I first did it as an independent consultant and now, I started my own part-time CFO and financial advisory company.

Why do companies want to work with you?

I get lots of requests from growing startups that need to get funds, investments and financial help. We usually work for companies and startups before their Series B funding. They don’t need a full-time CFO at that time, but need financial advisory. When they grow, find their product market-fit and start to generate revenues, they hire a full-time CFO.

Part-timing CFOs are really developed in the United States, but not that much in Spain because the ecosystem is not mature enough. Even if it’s a growing trend.

When a company hires you, what are you main missions?

It depends on the stage of the company. But, I can sum up my missions in two main categories:

  • Financial planning, budgeting, cash-flow analysis, forecasting, Business planning and monitoring Business Model.
  • And a more operational role that consists in implementing the right infrastructure and processes to support companies’ growth.

Startups also call me when they want to raise funds to prepare them and to make them investment-ready.

What are your main challenges?

Companies frequently call me in emergency situations, when they are running out of cash and need funding to keep living. I need to act quickly because the company’s survival depends on my actions.

The other main challenge is to support their growth by developing the right infrastructures. Which is far from being easy when there is everything that needs to be done.

How do you see the future for the CFO position?

I already see lots of changes since I started. At the beginning of my career as part-time CFO, when I went to propose my services to companies, they didn’t see the value I could give them.

Now it’s different, entrepreneurs come to find me for my help. Entrepreneurs have excellent technical skills but very few knowledge on finance. They tend to focus on their product and their market, rather than on finance. They want to delegate this time-consuming part of their business. They also have more pressure from investors, this is why they need external professionals to support them.

The ecosystem is maturing, becoming more professional with lots of new services for entrepreneurs and startups.

For the CFO position, it is really different whether you work for a startup or a traditional company. In the startup world, you are closer to the CEO, you are more involved in the company. Your role goes beyond your financial function and need to learn to work in a chaotic environment. You are like a business partner who needs to understand all the components of the company.