Turning bad debts into a profit? How forward flow transactions work.
It sounds paradoxical. One company constantly has outstanding receivables, another company buys them again and again and it’s a good deal for both of them? That’s right. But this is exactly how forward flow transactions work. We explain what the business model is all about.
Payment defaults are simply a fact of business. Nearly every company has receivables that remain unpaid, not just now and then but continually, depending on the sector and line of business. Forward flow transactions can offer a solution to this problem.
“Forward flow transactions enable companies to sell unpaid invoices to a debt collection company at defined intervals and at an agreed price,” explains Yves Van Nieuwenburg, Commercial Manager at EOS Contentia in Belgium. “It’s a potential win-win situation. Our partner sells their debts at regular intervals so gets money for debts that have not been settled by the end of their internal collections process.” And the transaction is profitable for EOS as well: “Because we carefully calculate the possible debt collection costs.”
In Belgium, EOS is playing a pioneering role with this approach. The following six steps describe how a case of bad debt, considered individually, can be turned into a successful collaboration.
1. A company wants to monetize bad debts.
Take an energy utility, for example, which has a constant stream of unpaid bills. After sending out several reminders, eventually the company turns off the customer’s electricity. The utility’s internal debt recovery options have therefore been largely exhausted, but the company would like to monetize the debt if possible. It therefore decides to sell a steady flow of these receivables over a specific period.
2. EOS analyzes the data.
To conclude a forward flow agreement with EOS Contentia, the utility specifies which bad debts it would like to sell and at what intervals, and also provides data on these outstanding receivables. “This phase is crucial,” says Van Nieuwenburg. “The more data we have, the more accurately we can calculate our price for the debt.” Because it is above all on the basis of this data, which are processed anonymously and in compliance with data protection regulations, that the team works out the purchase price for the debt portfolio. Pricing is complex and involves several colleagues from various departments in Belgium and from Risk Management at EOS in Hamburg. “The outcome of the deal depends on our analysis and calculations,” says Van Nieuwenburg.
3. The parties agree on a fixed price
After all this number crunching, EOS Contentia submits an offer. For example, the parties might agree that EOS will continually buy outstanding receivables over a period of one or two years at a fixed percentage of the nominal value of the amounts payable – a steady flow, so to speak. “This takes a lot of discipline and trust,” says Van Nieuwenburg. “We need high-quality data and reliable calculations on the collection forecasts, costs and other parameters to be able to price the deal correctly. And we need to have confidence that the quality of the data that we have based our analysis on will remain consistent over the course of the contract.”
4. Regular debt purchases start.
After the seller and EOS Contentia have signed the contract, the regular debt purchases can begin. For example, EOS Contentia will buy debt packages at intervals of one, two or four weeks. The utility company we are using as an example can then take these bad debts out of their balance sheet and receive cash payments instead.
5. Recovering the receivables
Now that EOS Contentia owns the debts, it sets about collecting as many of them as possible. In the last year, for example, Van Nieuwenburg renewed a contract for a total annual volume of EUR 9-11 million, involving around 15,000 debts a year. “Our collection strategy is based on the data that we analyzed in anonymized form”, explains Van Nieuwenburg. “This allows us to decide which debts to collect first and how to prioritize the others.” In this context, details such as the debtor’s date of birth and anonymized information about whether they own a house or other assets are useful. It goes without saying that EOS observes the strictest data protection standards and internal provisions.
6. Long-term relationships with all stakeholders are the goal.
The main objective in recovering the debts is to reach the quota forecast in the pricing calculations. “This means that not only can we calculate a good price for our customers but we also communicate with the debtors over a long period and give them the opportunity to spread their payments through instalment plans, for example”, says Van Nieuwenburg.
Ideally then, this will bring about the ‘win-win situation’ described by Van Nieuwenburg. And this ideal situation is the rule. In Belgium, EOS Contentia is already seen as a major player on the market, Van Nieuwenburg says. At the moment, it is mostly telecommunications companies, e-commerce firms and energy utilities that are exploiting the forward flow process to monetize their bad debts. Nevertheless, Van Nieuwenburg is confident: I expect business volume to grow in the next few years."
The outcome of the deal depends on our analysis and calculations. Yves Van Nieuwenburg, Commercial Manager at EOS Contentia in Belgium.
Photo Credits: EOS / Credit Expo, Stocksy / Milles Studio, shutterstock