Disadvantages of Debtor Finance

Like any business financing solution, debtor financing has a number of advantages and disadvantages. This article presents the most important disadvantages of this product to help you determine if this financing solution is right for your company.

Debtor finance solves only one specific problem

The most important limitation of debtor finance is that it solves only one specific cash flow problem. It improves your cash flow if your you cannot afford to offer net-30 terms to clients or if clients are paying slowly. Otherwise, debtor finance is not of much help if you need financing for other purposes, such as buying equipment.

Debtor finance is available only to certain types of businesses

Debtor finance solutions, such as factoring and invoice discounting, can help only those companies that sell products and services to other companies. Also, the company that pays the invoice (the debtor) must have good commercial credit. If your company sells directly to consumers, or if your commercial clients don’t have good credit, debtor financing can’t help you.

It’s more expensive than alternatives, such as overdrafts

In general, debtor finance interest rates are significantly higher than the rates of other financing solutions, such as overdrafts. Therefore, debtor financing can be used only by businesses that have relatively high gross profit margins.

The financier usually secures its position against all business assets

Most transactions have a security deed against all assets of the business, not just the debtors. If you need additional financing or if you need to sell an asset, your company must obtain a release from the financier.

The financier usually takes over the whole ledger

The finance company usually takes over the management of your whole debtor ledger. This management can be a problem if the client wishes to retain control of customers who are especially important or sensitive to the business. Note that this disadvantage does not apply to most invoice discounting lines.

Some customer involvement may be necessary

There are two types of debtor finance solutions: confidential and disclosed. As its name implies, a confidential facility is not disclosed to your account debtors. This type of facility provides a number of advantages for the client but increases the risk for the financier. Therefore, confidential facilities are offered only to clients that have solid financial statements.

Disclosed facilities, on the other hand, require that your customer be notified through a notice of assignment. They also require that invoices be periodically verified. Financiers usually have processes in place to minimize the impact of verification.

Businesses need to have a certain turnover volume

Most debtor finance facilities are offered to companies that have a minimum monthly turnover of $100,000. Unfortunately, debtor finance is not available to smaller businesses.

Some situations may required audited financial statements

In some cases, the financier may request that you provide them with audited financial statements. This scenario increases your cost for the service.

Is debtor financing the right choice for my company?

The benefits and drawbacks of  using this type of financing depend on your individual circumstances. Generally, a debtor financing programme improves your cash flow and helps your business if your company has:

  • Creditworthy commercial customers
  • Customers who pay you in 30 to 60 days
  • Cash flow problems due to slow-paying clients
  • Reasonable profit margins
  • Good relationships with its customers

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