When a business provides a product or service, it issues an invoice to its customer. The business then usually allows its customer to pay the invoice typically within 30, 60 or 90 days. One of the reasons why businesses agree to offer extended payment terms is that by offering such flexibility, it builds trust and loyalty with its customers. It also makes it easier to win larger orders, which means more revenue.
However, while the business is waiting to receive payment, it has to deal with a short-term gap in cash flow that might be holding the business back. In order to bridge that gap, many small Australian businesses choose finance instruments like a business loan or an overdraft facility. Debtor finance (also known as Invoice Finance, Receivables Finance and Factoring), on the other hand, is an alternative type of business funding that may be better suited to expanding businesses.
The business can use outstanding invoices to secure access to a percentage of the invoice (generally up to 80% of the invoice value) in return for a fee. In other words, with debtor finance, companies can get an advance on the funds they are owed. It can be an efficient way for companies to resolve cash flow issues that result from deferred methods of payment.
A benefit of debtor finance is that the borrower doesn’t need to offer property as collateral.
Debtor finance is a useful financial option for cash strapped businesses or ones with a long working capital cycle. Businesses can use debtor finance to cover cash flow gaps or as a part of a long-term growth strategy.
Who is Eligible for Debtor Finance?
While eligibility requirements for debtor finance are not as strict as they are for other finance options, borrowers still need to meet certain criteria. Typically, a business will need to show that:
- Its customers are other businesses (i.e. B2B)
- The invoices are not over 90 days old
- The invoices have not already been used as collateral
As a part of its application, a business will have to provide the following information:
- Financial statements (although not always required)
- Aged Debtors & Creditors Listings
- The debt collection and credit process (i.e. examples of issued invoices, terms payment etc.).
Supply Chain Finance
A related finance instrument is Supply Chain Finance (sometimes referred to as ‘reverse factoring’, which is slightly different but works in a similar way.
In a supply chain finance context, the business that provides goods and services can offer their suppliers payment immediately by financing their supplier invoices. The supplier then takes payment immediately rather than waiting the full payment term. This may result in a discounted invoice due to early payment.
Businesses must have high credit ratings in order to be eligible for supply chain finance. This financial instrument is available to a wide range of industries including:
- Communications & IT
- Energy utilities
- Industrial manufacturing
- Transport & Logistics
- Wholesalers & Distributors
- Some construction industry businesses (not including developers)
Difference Between Debtor Finance and Supply Chain Finance
With debtor finance, the financial institution is funding the business’ customer invoices.
Whereas, with supply chain finance, the financial institution is funding the business’ supplier invoices.
The Advantages of Debtor Finance Over Traditional Loans
Debtor finance provides a rapid solution to businesses that are growing or need to improve their cash flow by giving them access to working capital quickly. Debtor finance is also more flexible than a bank loan or an overdraft, which are generally limited by the value of the security offered.
Also, debtor finance provides businesses with flexibility because it can exist alongside other loan types such as asset finance, overdrafts and traditional term loans.
Also, this type of debt instrument is not usually considered a limit and is often considered an ‘off-balance sheet’ facility, which means it does not reflect on a business’ balance sheet. The reason for this is because you cannot borrow more than you are owed and thus, the limit is deemed repaid and cancelled once the invoice is paid back to the lender.
Another advantage of this type of lending is that you only usually pay for what you use, therefore there usually aren’t any fees to establish the facility or ongoing fees. Of course this varies from lender to lender.
Are there any Potential Issues with Debtor Finance?
One of the disadvantages is that debtor finance is typically more expensive than other financial instruments, such as overdrafts or term loans. So, debtor finance is a suitable option for businesses that do not have property to offer as security and that do not work on tight profit margins.
Another disadvantage of this debt instrument is that does not suit all businesses. If a business is billing their clients for works not yet completed, this may pose an issue for some debtor finance lenders and they may generally decline to fund those invoices.
Who Offers Debtor Finance?
In Australia, there are a few specialist lenders that offer debtor finance and only a couple of the major banks still do.
While going directly to these lenders to discuss debtor finance is undoubtedly an option, it’s worth seeking advice from experienced and accredited finance broker beforehand to make sure and that a potential lender and this product is the best fit for your business. Aviator Advisory will help you find a financial instrument that will best suit your cash flow requirements among a panel of many lenders. We have worked with many businesses (new and mature) to assist them with debtor finance and other working capital solutions, across a diverse array of industries and corporate structures.
Disclaimer: The information provided herein is for general information purposes only and does not constitute specific advice. It should not be relied upon for the purposes of entering into any legal or financial commitments. Specific advice should be obtained from a suitably qualified professional before adopting any investment/financial strategy.