Understanding Debtor Financing
Cash is the oxygen for business, but many operate on credit. So as sales increase, cash may be tied up in debtors’ books for the coming 60 to 120 days and there are still expenses that need to be paid. The lack of cash flow can have a devastating effect on your business operation. This is where debtor financing can help.
What is Debtor Finance?
There are two popular forms of debtor finance. Invoice discounting releases the cash flow locked up in your outstanding invoices by advancing up to 85% of what you are owed from customers. The remaining 15% is returned to you when your customers pay their invoices, less a small fee. So this way, you can have access to the cash from your sales quickly, leaving you to get on with managing the growth of your business
Invoice factoring works the same way but customers are made aware that a finance company has responsibility for debt collection. The benefits of this option are additional credit management and support. Customers are instructed to make payments to the financier directly and the financier will provide debtor management to assist in prompt collection. This is an attractive option for those businesses that have long payment cycles and want to streamline their administration process in managing and chasing down outstanding debts.
Why use it?
Traditionally businesses have relied on banks for credit using a bank overdraft to access more cash. However, having to jump through hoops to get a bank loan can slow things down. Once pre-approved debtor finance is fast, often cash can be provided almost immediately and does not require using directors assets as security. Debtor finance relies on receivables and the quality of the debtor’s ledger so there is less reliance on trading history, profitability and balance sheets.
Is it right for my business?
While there are numerous benefits using debtor finance, it is important to note that it is not suitable for every business and situation.
Generally, businesses selling to a single large customer or selling under a retainer or progress payments are not suitable for debtor finance. This typically includes construction and IT services.
Debtor finance is particularly suitable for businesses that operate using account receivables such as a wholesaler, manufacturer, distributor or those in the service industry.
If used prudently debtor finance can provide much-needed cash for a range of purposes such as growth, supporting mergers, acquisitions, management buy-outs and succession planning. Debtor finance can also help during restructuring with a reliable cash flow.
It is easy to see why the use of debtor finance is on the rise in Australia as a flexible, efficient and fast funding arrangement for small to medium businesses.