What is Contra Risk?
In some situations, a business may buy and sell goods or services from and to the same company. In other words, the company's customer is also its supplier. For example, Company A might buy some components to manufacture an end-product from Company B. Company B might sometimes buy parts from Company A. This is sometimes called reciprocal trading or contra trading, the word "contra" meaning opposite.
In a factoring or invoice financing context, if a client has debtors that are also suppliers, it is a potential problem. We expect every invoice that is financed to be collected from the debtor. These collections effectively repay the financing facility. If a debtor is also a supplier to the client, they may well be owed money by the client for goods or services supplied. Rather than pay an invoice, the debtor could simply decide to offset what it is owed as a supplier. This would effectively reduce the amount collectable, resulting in dilutions in the form of adjustments/credit notes, etc. For the same reason, receivables on related companies (debtors with the same shareholders or which are parent/subsidiaries) are usually refused by Factoring Providers, as inter-company compensation may apply.
The impact to debtors
To deal with this risk, factoring companies first need to know that this exists. This is probably going to be detected during the on-boarding stage for a new client of via regular field audits. Debtors that are also suppliers may be excluded from the factoring agreement via a blanket disapproval or individual invoices disapproved or made ineligible (contra disapproval) to reduce the amount of funding. The factor may simply reduce the advance rates to increase their reserve/retention in the availability calculation. At the end of the day, having a contra-risk doesn't mean that the invoices definitely cannot be collected. If they weren't pre-financed due to contra risk, the client will receive the money when the debtor pays the invoice instead.
With the advent of data extraction directly from the client's accounting system, it is possible to be more sophisticated and to extract the purchase ledger (accounts payable) as well as the sales ledger (accounts receivable). This allows contra risk to be managed because we know the accounting position on both the supplier and the debtor side. Knowing the balance outstanding as a supplier (the "payables" position) allows the contra disapproval figure to be calculated. If the balance of the sales ledger is less than the balance of the purchase ledger, then disapprove the whole sales ledger balance, otherwise, disapprove the sales ledger up to the balance of the purchase ledger balance.
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