Is a debtor financing right for my business?

Lender pays you percent of your unpaid invoice now (e.g., 80%). You receive remaining invoice (e.g., 20%) value minus lender fee when your customer pays the invoice to the lender.

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Debtor financing overview

What is debtor finance?

Debtor finance is a financing solution that allows a business to use its accounts receivable ledger as collateral for funding. Debtor financing is commonly used by invoice heavy businesses as a way to manage working capital. Due to relatively high interest rates when compared on an annualised basis, a debtor finance facility is usually managed as a short term cash flow solution. Generally, a debtor financing service will pay you up to 80% of your outstanding invoice value now, and pay you the balance after customers fulfil their payment requirements (minus a fee for providing the early money).

Debtor financing is broken in to two different classifications:

  • Invoice discounting
  • Invoice factoring

Invoice discounting

With invoice discounting — you as the business will continue to manage collection of payment from the invoiced customer.

A business owner will need to ensure dedicate time and processes are in place to follow up on debtors and their payment terms.

As invoice discounting involves some degree of trust on the behalf of the lender in the loan terms, the lender tends to be more likely to offer this solution to more established businesses with larger turnover from trusted debtors (e.g., large companies, or companies with a positive track record of debtor financing arrangements).

Clients are unaware of any invoice discounting arrangement.

Invoice factoring

The other form of debtor financing is invoice factoring – where the lender takes over payment collection process on invoices due to the borrowing organisation. Invoice factoring organisations will therefore call and chase down the customer to request payment when the payment deadline comes up, as well as pursue any further collection processes (if necessary).

Invoice factoring allows the business owners to focus on other areas of the business and not chase payments of debtors. Clients will know that the business owner is using a factoring solution due to collecting their payments.

As invoice factoring is more labour intensive for the lending organisation, invoice factoring arrangements are often more expensive than invoice discounting.

Benefits of debtor finance

Debtor finance enable business owners to solve their mismatched cash flow problems, giving them access to already earned cash. This allows businesses to pay important expenses in the present without fearing about low cash flow issues.

Debtor finance also allows your business relatively quick access to cash compared to other loan products and unlike other products is flexible and develops with your business as it is secured to the accounts receivable ledger - as a business grows its account customers, the ability to increase debtor finance facility also increases.

For organisations with poor account receivable processes, invoice factoring could be an easy solution to outsource and improve the collections process.

Drawbacks of debtor finance

Debtor finance is a specialised finance solution for organisations that sell products and services on payment terms. Other business forms that do not rely on accounts receivable would not qualify for this form of financing.

Debtor financing also tends to be more expensive compared to other products, and businesses tend to need to have to meet a certain level of revenue in order for a lender to agree to debtor financing.

Business owners choosing invoice factoring will cede overall management of their accounts receivable ledger potentially highlighting to their clients the lending and collections arrangement.

What is the best way to use debtor finance?

If your organisation has a large accounts receivable ledger and as such, potentially falls into a temporary period of low cash on hand, a debtor finance solution could be your best response. Due to the relatively high annualised rate of a debtor finance facility, it is often advisable to view debtor finance as a purely short term cash flow solution – viewing longer term finance solutions for other projects.

Applying for debtor finance

Applying for debtor finance is quite similar to applying for other loans in that you will have to provide business bank/ financial statements. A large accounts receivable volume will be a determining factor here for any lender considering the provision of a debtor financing solutions.

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