Does your business have cash flow issues and you’re unable to receive bank funding, debtor finance is an option.
But what is debtor financing and is it suitable for your company? Read on to learn more about how it works and if you can benefit from it.
What Is Debtor Finance and How Does It Work?
Debtor finance is a generic term, which refers to products that fund companies through financing invoices.
Usually, companies providing goods or services have invoices with various payment terms, which vary between 30-90 days. They can receive an advanced on the money owed with debtor financing to keep the cash flow balanced. This is helpful for businesses with long working capital cycles and cash-hungry companies.
There are various benefits to debtor financing over traditional loans. For instance, when your company is growing quickly, you have access to working capital much sooner.
When you grow with more sales, the invoice ledger would grow as well, but you still won’t have the money to use as capital yet. With debtor finance, you can tap into the finance and invoice as sources of funds to continue working with.
Furthermore, debtor financing is more flexible compared to overdrafts or bank loans, as these are limited by amounts of attached security. This type of financing gives you more control over cash flow and provides better credit control.
There are two common types of debtor financing, which are:
- Invoice factoring
- Invoice discounting
Both forms have similar benefits and would solve some problems, though working differently and has different features.
Invoice Factoring
Invoice factoring is usually for small companies with cash flow issues. There are three kinds of solutions, which are to fund, credit advice, or offer collection assistance.
Invoice factoring would work by financing the invoices individually, typically in two installments. The first installment would cover up to 85% of the invoice’s total value, deposited to the bank after it’s processed.
The second installment, which is remaining from the total value, will be deposited to the bank once the client pays their invoice in full. Many companies use this type of debtor financing to improve cash flow.
Invoice Discounting
Invoice discounting is typically for larger companies with established collections and credit procedures. The solution would only provide funding, with credit and collections handled by the client instead of the finance company.
The line will operate as revolving financing facilities, with the available amount decreasing as clients pay invoices. It would increase when raising new invoices.
Clients finance invoices in batches instead of individually. Most of the invoice batches would be financed for up to 80%, basing on the invoice credit quality. But actual financed percentages would also vary on underwriting criteria and the clients’ needs.
Who Can Benefit From Debtor Finance?
Debtor finance is best for businesses and companies with a long lead time between purchasing inputs and receiving money from the final invoice when sales are completed.
Industries under manufacturing, transport, or wholesale, as well as the fashion industry, are optimal examples.
With that in mind, not all industries will be suitable for debtor financing. Sometimes, the ledgers won’t suit it due to contractual obligations being gone in work.
Any Issues With Debtor Finance?
The only main issue with debtor financing is if you don’t pay enough attention to it. You will need to manage your debtor finance and comply to any rules and regulations stated.
In worst-case scenarios, your business may run out of money completely, as the debtor financier finds out that debtors haven’t been managed well and are older than 90 days, so it can’t advance more funds.
Besides this, the declining market is a risk. Businesses with $500,000 worth of invoices now may have invoices of only $250,000 the next month. That’s why it’s crucial that if you have debtor finance, you still have to continue to monitor your working capital and its movement, as well as making sure you receive what you’re owed from clients.
Also make sure that you read up the costs and terms of debtor finance, which would vary per financial institution.
In general, anything invoiced and up to 90-days-old can be funded. You receive different costs and charges depending on the risk and facility type the funder offers. Furthermore, the charges also depend on the industry you’re in, as well as the ledger size, amount of work you expect, and more.
Note that companies that have gone through some invoice issues may receive more expensive finances and rigorous checks as well, compared to other competitors. But beyond looking at the charges, you should also focus on the solution and if the finance can give you more profitable opportunities and the working capital needed to keep going.
If you’re looking into getting debtor finance, you can contact ABR Debtor Finance Team to learn more about what it entails and the specific costs according to your individual needs and business type.
Greetings, dear readers! I am Rohini. As a proud contributor to the Worthview blog, I am excited to bring you insights into the realms of fashion, beauty, and health. Let’s embark on this adventure together, where my words become a bridge between my world and yours. I look forward to our shared journey of discovery and connection.
