Factoring Companies Guidebook

Any situation where a product is replaced after delivery of the original, or goods ordered are substituted for others.

See also: - "Rework", "Stock Rotation and Rectification", "SOR/SOE"

Concerns

The reasons why products are replaced may be due to faulty goods, being out of season and out of fashion or obsolete. These can be indicators of underlying problems with the business in terms of product quality and control, poor planning, a lack of understanding of the markets in which they operate and not being competitive or lagging behind the rest of the market. Every time a product is replaced it means that payment will be delayed and no payment will be made until the customer receives the replacement, at which time it may consider that to be the start of the agreed payment terms. If the replacement is due to poor quality and this is consistent, the customer may even delay payment until replacement has been proven for a period of time. All the time the invoice is likely to have been funded by us and the likelihood of repayment is reduced or delayed.

Of further concern are situations where the Client, on issuing a replacement product, may also submit and assign a new invoice, against which we may advance funds. Until such time as a credit note is issued for the original invoice, we may well be funding the same debt twice. Credit notes may also not be issued until the original goods have been returned, which may be after the replacement has been dispatched, or until they have been not only returned, but also tested, if of a mechanical or electronic nature.

Product replacement is prevalent in the computer industry, where there are usually expected to be a certain percentage of goods delivered which do not work, often referred to as 'Dead on Arrival' or DOA's.

Product substitution arises where the Client may deliver and invoice goods other than those ordered due to 'out of stock' positions. There is no guarantee that these goods will be accepted by the customer and therefore paid. These substitute products may be of a lesser quality, therefore pricing may need to be adjusted, or of a higher quality but invoiced at the price of that ordered. In either case, the Client's margins will be reduced, therefore adversely affecting its profitability, but this may, if due to 'out of stock' positions, also indicate inherent cash flow problems, with creditors restricting supply or refusing to accept or deliver orders until they have been paid. However, if there is a genuine and acceptable reason for goods being out of stock, the Client may be substituting products to retain customer loyalty. Product substitution is prevalent in the Drinks industry particularly in the peak season leading up to Christmas, where demand can often exceed supply.

Identification

Review both invoices and credit notes for indicators of replacement goods. Make enquiries of the Client as to the amount of returned stock awaiting credit or testing and also review the credit notes pending file.

Review remittance advices for potential debit notes raised by customers.

Review Client's and customers terms and conditions for their ability to deliver or claim replacement or substitute products.

Enquiries should be made of the Client as to whether the nature of the business has changed, which may lead to a change in the profile seen by us.

Treatment

Any replacement invoices should not be funded until either the credit note for the original invoice is issued or the funding of the original withdrawn. We should satisfy ourselves as to the reasons for product replacements and the customer's liability to pay, particularly with the substitution products.

Where product replacement is a regular feature and there is a material delay to the raising of credit notes, a reserve should be put in place to cover our exposure and/or the PPF reduced to maintain the margin of security.