Debtor finance is a term used to describe a number of different type of funding mechanisms that businesses use which involves using its accounts receivable as security. The fact that debtors can take between 30-90 days can prove to be a significant cashflow drain to some businesses. Even if a business is experiencing significant profitable growth, this cashflow drain can cause substantial cashflow strain. For the right business, debtor finance solutions can meet this cashflow gap and allow the company to more appropriately manage their operating expenses.
Security requirements vary depending on the specific debtor finance funding type but most focus on the value of the debtor’s ledger, supported by a charge over the business, along with the personal guarantees of directors. Apart from some specialised lenders, traditional property security is not taken. Since the funding depends on the value and collectability of the accounts receivable amount, most debtor finance credit lines will automatically increase in response to increases in sales, and provide ongoing working capital to fund the growth of the business. Typically, debtor finance funds between 70%-90% of the debtor book. The remaining 30% to 10%, known as the 'retention' is released following receipt of payment of each invoice by the debtor.
Debtor finance products, by whatever name, essentially fall into two categories:
Confidential: the customer or end-user is unaware of the funding being provided, usually called 'invoice discounting'. Some facilities marketed as 'confidential' still require completion of anonymous 'audits' before invoices are funded.
Disclosed: traditionally referred to as 'factoring', where invoices have a notice that warns the customer to pay the funds to the financier in settlement of the debt. Due to the involvement by the financier with a factored customer, the advance rate on such invoices is higher than with a confidential facility.
How does debtor finance work?
Most financiers will fund invoices for up to 90 days from the month the invoice was issued. For debtors who take longer than 90 days, the financier will usually require the funding to be repaid by the customer, or more practically, the funding limit will decrease by this amount. 120-day recourse periods are provided in exceptional circumstances.
Financiers may insist on the client taking out credit insurance on their customers, with the policy and benefits assigned to the financier.
Credit limits may also be set on individual customers to minimise risk by some financiers, and 'concentration' limits might also limit funding available to major customers, or to specific classes of customers.
An in-depth knowledge of all these issues is essential be able to choose the right debtor finance solution with the best financier. If you have any questions, please feel free to call us directly on 1300 96 25 95.
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Other forms of finance:
Asset Finance: There are many types of asset finance offered by banks. Choosing the right option has both cashflow and tax implication.
Commercial or Business Loans: Commercial loans or business loans are the primary source of funding when you need the money for a term longer than one year. The debt can be secured by traditional residential or commercial property, “non-traditional” assets as well as the business itself.