Home Finance Factors Must Remain Vigilant as Fraud Could Derail Business Funding

Factors Must Remain Vigilant as Fraud Could Derail Business Funding

by internationalbanker

By Kevin Day, CEO, HPD LendScape

COVID-19 has significantly impacted the liquidity of businesses worldwide, driving up the demand for funding and loans from nearly every corner of the global economy. As the effects of the pandemic continue to put strain on businesses’ operations, lenders should be prepared for a potential increase in fraudulent activities as cash-poor companies feel pressures increase.

Indeed, in the UK £26bn from the COVID-19 loan schemes is estimated to have been lost to fraud, organised crime or defaults – a challenge reflected across other European countries that have redirected resources to auditing relief programmes. Similar issues are on the rise in North America, with a recent report by LexisNexis Risk Solutions suggesting that COVID-19 has prompted a spike in the cost of fraud for institutions.

With the risk of fraud increasing for lenders, the factoring industry must be especially cautious navigating this threat, particularly as small businesses less able to leverage bank loans seek alternative sources of working capital. Consequently, factors must be aware of the ways in which factoring fraud commonly transpires and be ready to take the necessary measures to prevent it from occurring now and beyond COVID-19.

Fraud comes in several forms

Each instance of factoring fraud contributes to the vast $4.94 trillion lost to corporate fraud globally every year – a sum equivalent to the combined GDPs of Italy and the UK, and one which would be far better utilised as legitimate business funding during the current crisis. As a result, it’s vital that factors recognise the types of fraud they might face in the coming months.

Factoring fraud broadly falls into two categories: premeditated and circumstantial fraud. Both involve the assigning of illegitimate invoices, for supposed business between a supplier and its customers, to the lender in order to obtain advance payments. However, the two types of fraud vary in important ways.

The former arises when organised criminals try to exploit holes in a factor’s due diligence processes. By setting up fake businesses and customers, premeditated fraudsters try to convince factors to issue a facility and make payments on it. Circumstantial fraud occurs when real, struggling business-owners seek to increase cashflow by optimistically issuing invoices to their factor ahead of schedule. This kind of early invoicing is commonly called ‘pre-invoicing’ in the factoring sector. Unfortunately, this practice of pre-invoicing can quickly descend into the fabrication of fake invoices as the business-owner battles to keep their business afloat.

Recognising the signs

Ensuring that lenders recognise the tell-tale signs of fraud of either variety is critical in reducing its potential impact on an organisation. One of the most common signs of premeditated fraud, for example, is the business issuing the invoices having a “perfect” record. Another easily recognisable red flag is if the issuing business’s sales are mostly or entirely to new customers, signalling that these supposed customers could be fake. Trend analysis, in particular the drop off of cash receipts, the increase in dilutions (e.g., credit notes) and a sharp increase in sales can all be indicators to trigger greater scrutiny of the business before it’s too late.

Unfortunately, it can be more challenging to detect cases of circumstantial fraud due to the existing facility and relationship the factor has with the borrowing business. However, continually re-evaluating the performance of and the underlying conditions facing the borrower is critical to understanding the pressure under which the business is operating: if new problems are impacting the business, there is increased potential for an invoice to be invalid.

Prevention is the best cure

Nonetheless, an effective first step in preventing fraud is acting to mitigate the risk of it happening in the first place as much as possible. Education and awareness play an important part in this effort. By training staff to be able to recognise the common signs of fraud and by implementing the correct data collection, trend analysis and due diligence processes, factors should be able to identify fake invoices as and when they arise – not after the damage has been done.

Another core part of fraud prevention, once a business relationship is established, is verifying invoices. This could take the form of a physical review of the relevant documents, or e-invoicing, or could even mean a telephone call to the debtor to verify that, firstly, the debtor is in fact real and, if so, that the invoice is in line with the debtor’s expectations.

Technology offers solutions

More recent innovations have also meant that technology has provided answers. Indeed, receivables finance technology has evolved through each economic crisis in past decades to incorporate proven best practice, algorithms and processes, that provides greater efficiency and visibility into the lending process, helping to protect lenders as much as possible.

Verification and sampling of invoices, for instance, can be a time-consuming and manual task at high-risk of human error; however, digital solutions can optimise this process, with a formulaic sampling of invoices and workflow automation to ensure the task is done efficiently, effectively, backed up with an audit trail to discourage carelessness. The ability to set-up a shadow-ledger, for example, also offers lenders detailed automated monitoring of the receivables. These steps can further be digitalised through the collection of data straight from the accounting system of the client, streamlining and adding greater transparency to the process.

As lenders face the increased threat of fraud in this period of uncertainty, which looks set to continue, it is vital that steps be taken to mitigate this risk. Not only will these efforts prevent incalculable losses by lenders to fraudsters, it may well help to prevent lenders reducing their support altogether at a time where businesses need it most.


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