Misdirected payments: finding them on the bank statement

On a notification facility, the client’s customers have been told to pay the factor: to a lockbox, or by ACH or wire to an account the factor controls. A misdirected payment is one that goes to the client instead. Sometimes it is a customer paying out of habit to an old address. Sometimes the client asked it to. Either way, the factor has bought an invoice and the cash has gone elsewhere, while the invoice still shows as open on the aging.

Why it matters

A misdirected payment is not always fraud. Customers make mistakes, and many clients turn the money over promptly. But every misdirected payment is cash outside the factor’s control, for a time at least. A pattern of them is one of the clearest early signs that a client is in trouble. Diverting collections is often how a business under pressure bridges a gap, and the habit is hard to unwind.

Where to look

The client’s operating account statements are the evidence. Ask for every account the business uses, not just the main one, for the whole period since the last exam. Then read the receipts.

List every deposit from a funded customer. Start with the customer names on the aging and your schedules of accounts. A deposit described as “ACH CREDIT BIG RIVER GROCERS” in the client’s own account is a receipt from a customer you have funded.

Match each one to what reached you. For each receipt, look for a payment from the client to the factor of the same amount, soon after. A deposit followed by a matching turnover the next day is a customer error handled correctly. A deposit followed by nothing, or by a smaller amount days later, is a misdirected payment that wasn’t turned over in full.

Use each turnover once. Two receipts of $4,200 and one transfer to the factor of $4,200 means one was turned over and one wasn’t. Matching both to the same transfer hides the second.

A deposit followed by a matching turnover is an error handled well. A deposit followed by nothing is the finding.

Why batched remittances need a person

Customers often pay several invoices in one payment, and clients sometimes turn over several receipts in one transfer. A transfer of $18,640 may cover receipts of $4,200, $9,100 and $5,340, or it may not. Working out which receipts a batch covers by trying combinations of amounts finds false matches easily. A transfer that happens to equal the sum of three receipts proves nothing.

Leave batches unmatched until someone has the client’s remittance detail. The client should be able to show which receipts each transfer covered. If it can’t, that is a finding in itself.

Other signs in the same statements

• Receipts from customers that aren’t on the aging. A new customer not yet scheduled to the factor, or a customer whose invoices are being kept off the schedules.
• Changed payment instructions. Invoices carrying the client’s own bank details, or a remit-to address that isn’t the lockbox. Check a sample of invoices as issued, not as copied for the schedule.
• Round-sum transfers in and out with related companies. Money moving to an affiliate shortly after customer receipts arrive.
• Overdraft relieved by customer receipts. An account that runs overdrawn and is brought back by a customer deposit tells you where that customer’s money went.

How often to look

Reading bank statements only at the annual exam leaves a year for a habit to form. Ask for the operating account statements monthly, with the borrowing base certificate or the schedule of accounts, and run the same matching each time. It takes little time once the funded customers are listed. Trends show up early: a few misdirected receipts a quarter becoming a few a week is the change worth noticing, more than any single payment.

Check the notice of assignment

Every misdirected payment raises the question of whether the customer knew where to pay. Check that a notice of assignment was sent and acknowledged for each customer whose payment went astray. If a customer never acknowledged it, verification starts there. A customer that acknowledged the notice and still paid the client may have been asked to.

What to ask the client

1. Which receipts from funded customers came into the client’s accounts, and when each was turned over.
2. The remittance detail behind every batched turnover.
3. Copies of invoices as sent to the customers, showing the payment instructions.
4. Every bank account the business and its affiliates use.

Then call a sample of the customers yourself. A short verification call asking where they last paid, and to what account, often settles in minutes what the statements leave open. Note who you spoke to and what they said, so the next exam can start from it.