Using debt facilities to manage cash flow is a key success strategy for most businesses. In our last post on supply chain finance, we discussed ASIC’s finding that insufficient cash flow is a primary cause of insolvency in business. Two less complex, but highly efficient cash flow funding options are invoice discounting and invoice factoring, these are known more broadly as debtor finance. Invoice discounting and factoring uses the value of your outstanding invoices or receivables for immediate cash
1.How Can Invoice Discounting and Factoring help my business grow?
Debtor finance can provide fast funds to smooth fluctuations in cash flow and fund growth. This form of finance means your business can receive payment on invoices within one to two business days once the facility is established, and utilise the improved cash flow position to benefit the company. For example, to obtain early settlement discounts from suppliers/creditors. Small to medium-sized businesses often have limited ‘hard’ assets (such as real estate) to increase their current borrowing are well positioned to benefit from this form of finance. Debtor finance can provide a higher level of funding than an overdraft. It also provides increased access to funding as sales grow, usually 75-90% of your debtor ledger. Debtor finance usually leaves other business assets unencumbered and available for other leverage opportunities.
2. What are the key differences between invoice discounting and factoring?
The difference between invoice discounting and factoring lies in the way the facilities are operated and the services provided by the financier. Invoice discounting is a confidential loan made to your business against outstanding debtors. These debtors (i.e. your business clients) are not made aware that the debts have been sold or encumbered. Your business continues to manage invoicing and debtors with the financier in the background. Invoice factoring, in contrast is a loan or sale of outstanding debtors where these debtors are made aware that the debts have been sold or encumbered to a financier. Payments must be made to the financier. The financier provides debtor administration services and follows up payments on your behalf, freeing up resources to focus on running and growing the business. Some businesses also find that the involvement of a third party, encourages debtors to pay on time.
3. How do I qualify?
If your business has high margin products or services, trade terms of 30-60 days, has clear, established debtor administration procedures and good credit control resources, you may well qualify for debtor finance. Larger lenders tend to limit invoice discounting to established companies with $2 m turnover, however there are specialist lenders who will support smaller and newer businesses. In general, retailers, contractors receiving stage payments, and business sectors with a disproportionate level of trade disputes are often unable to qualify for debtor finance.
The Debtor and Invoice Finance Association lists the following criteria for their members:
- A projected minimum annual turnover of around $200,000
- Goods should be sold on normal credit terms.
- A spread of debtors so that no one debtor is responsible for a large part of the total outstanding debt. (Although there are now a number of solutions for concentrated debtors)
4. What collateral do I need?
The great benefit of debtor finance is your outstanding invoices form the basis of your collateral. No property security is required. Financiers usually require a General Security Deed (an agreement between you and the lender), a Director’s guarantee and indemnity, and most importantly, assignment of your accounts receivables debt to the lender.
5. What does debtor finance cost?
The costs of a debtor finance facility are highly individualised, based on the quality of your business, the quality and number of your debtors and the type of finance you are seeking, but in general are comparable to an unsecured bank overdraft. A key difference between and overdraft and a debtor finance facility is the debtor finance facility generally grows in size as the business grows and debtors become larger. If you have a large number of customers with good credit, who pay their bills, the financier’s risk and their costs will be lower. If your business is struggling and needs cash to get back on top, lenders will reflect that risk in their rate. If you seek invoice discounting (a confidential loan) rather than factoring, lenders will potentially charge more for the perceived risk of debt collection. And lastly, if you are seeking finance on whole of turnover (all your receivables), costs may be lower than selective invoice finance.
While the terminology may vary between lenders, invoice discounting and factoring fee proposals typically include a due diligence fee, a service fee, a discount fee, and an annual minimum fee. More fees do not necessarily mean a higher total cost. It is critical to consider the total of each of the fees together on the debt facility.
This fee is only paid if you accept the financier’s proposal and covers the cost of credit reviews, filings and credit line preparation. Clearly, more complex businesses with larger credit lines will require greater due diligence costs.
The service fee is a percentage of each invoice that is financed. The rate is determined by factors such as the size of your line, your industry, credit quality of debtors, and individual considerations. Rates generally range from 0.30% to 3% per invoice.
The discount fee is essentially the interest rate on the funds advanced on your debtors, not the whole value of your receivables. The rate is commonly determined using a major bank indicator rate as the base plus an additional percentage determined by the financier. The discount fee (interest rate) is calculated daily but charged monthly, however not all lenders charge this fee.
Annual minimum fee
An annual minimum fee is simply the amount your financier projects they will make from your debt facility. You often won’t be charged this fee unless the service and discount fees are lower than this projection.
6. What are the time frame and terms?
Debtor finance facilities may be ongoing, tailored to meet the specific needs of your business, or sometimes have a fixed, generally 12-month term, however competition is now changing this requirement with ‘come-and-go’ style facilities becoming more popular offerings. Repayments are generally not fixed, as these are made by trade debtors, rather than your business. The lender controls 100% of the payments made by debtors and refunds to your business the balance of the payments once their fees and interest have been paid.
7. Do I have to open a new account to receive payments?
A new bank account may be required in the case of invoice factoring, when the finance is disclosed to debtors. If your business secures confidential invoice discounting finance, your normal bank account continues to receive payments.
8. Is this a recourse or non-recourse loan?
Debtor finance is generally a recourse loan. This means that if the value of the secured collateral (your debtor ledger) is insufficient to repay the debt, the lender has the right to pursue recourse over other assets or income.
9. What are the Loan limits?
Loans are generally 75-90% of the value of your debtor ledger. The quantum of your loan will depend on the value of your ledger bringing flexibility with your growth – the more sales you make, the more you can draw on debtor finance.
10. How do I get started?
The team at Grow Capital are here to help you determine if factoring or invoice discounting are the right solution for you. Grow Capital is a leading brokerage for debtor finance and can provide you with a competitive quote. Contact Gus Gilkeson [email protected] or Nick Wormald [email protected] today.
Grow Capital are a family owned Australian business, helping Australian business owners, investors, and individuals harness their capital growth opportunities through funding. They are on a mission to bridge the information gap between the funders who have the money and what they require, with the people who want that finance.
It’s time you embrace your funding opportunity – how can we help you?