Debtor Finance is not a dirty word…!
I am often amazed to hear people say that Debtor Finance is a bad product, or to hear an advisor telling their client not to use such a facility.
Sure, it doesn’t necessarily suit every type of business but…
To ignore a proven, well-established product, the origins of which are thought to date back to England in the 1400s, shows a lack of understanding about how debtor finance can and should be used effectively. In fact, many businesses have grown exponentially with this type of product.
This misconception seems to be unique to Australia where it is estimated that few eligible businesses use this type of finance, unlike in the UK and USA where take up and market acceptance is much higher. Part of the problem dates back to the 1970s when “factoring” earned a bad reputation; being seen as finance from lenders of last resort.
Nowadays with increased regulation, the lenders range from major banks, through to second tier lenders and specialised funders or niche one-off invoice financiers.
‘The industry has moved a long way since the early days and the Australian market has grown by more than 600% over the past decade. In 2011 alone, $61.4 billion worth of business was funded locally, growing at a faster rate than any other business finance product during that same period.’¹
So what is Debtor Finance?
Factoring, Debtor Finance, Invoice Discounting… call it what you will, these are all variations on the same theme.
Essentially it’s a product which allows a business to use its debtor’s ledger as security for a lender to advance funds. The lender will typically advance up to 80% of the total debtor’s ledger within about 24 hours and the remaining 20% (less any fees and interest costs) will be funded as and when the original invoices are paid by customers.
In the current economic climate where access to bank credit remains tight (see my previous blog post – How to Get Access to Capital in 2012) this is certainly one product business owners should seriously consider when restructuring or refinancing.
Economic conditions are likely to remain this way for quite some time and credit policy is generally more flexible for debtor finance than for most other business products.
How does it work?
As a recent example, a fast growing business with an annual turnover of several million dollars was consistently reaching the limit of their overdraft facility. Their current bankers would not increase this as they had some recent tax arrears and insufficient equity in their security property.
By sourcing debtor finance, this business now has in place a $750,000 facility limit, without the need for additional property security and room to further increase the facility if needed.
What are the benefits of Debtor Finance?
Some benefits of debtor finance are:
- It brings forward cash receipts to improve cash flow and working capital position
- The business can become a cash buyer and thereby negotiate significant price discounts
- No real estate security is required freeing up the owner’s personal assets
- Facility limit can grow along with the business where a traditional overdraft will not
- No need for refinancing – can be used alongside any existing bank facilities
- It forces the business owners to review and improve their own credit processes, documentation and systems
- Ensures the business instils a vigorous collections process. It can sometimes be outsourced to the debtor finance company at less cost than the salary of a collections clerk.
In addition to reviewing your business performance with simple management tools (see Elizabeth Mawby’s blog – Monitoring Business Performance), why not review the finance facilities to see whether debtor finance might enhance your business?
With a wide range of providers available in the market there is bound to be a provider that can assist your business.
To find out more about this type of product, please feel free to contact me. I look forward to hearing your comments and experiences with debtor finance.
Rob Kirkpatrick is a Client Director at Vantage Performance – an award winning, national business transformation and turnaround firm with proven success in solving complex financial, operational and people performance issues.
¹The Institute for Factors and Discounters of Australia and New Zealand (IFD), IFD Australia and New Zealand Inc., Sydney, 3 May 2012, <http://www.factorsanddiscounters.com/index.htm>