Debtor financing is an umbrella term that refers to a number of cash flow financing products. The two most common debtor financing products are invoice factoring and invoice discounting.
Companies use debtor finance because they have financial problems due to slow-paying clients. Often, they need to offer net 30 terms to clients even though they can’t afford to wait. Invoice factoring and discounting provide funding to the business. This funding allows your company to operate and grow. If you are not familiar with debtor financing, read “What is Debtor Finance?” first.
The debtor financing company you choose will be one of your most important business partners. They will provide your company with working capital, which is instrumental to your success. Therefore, it is important that you choose the right company.
Business owners should perform due diligence on their prospective debtor financing companies before partnering with a specific financier. This article helps you determine some important areas to examine while performing your diligence.
1. How long have they been in business?
It’s best to work with a company that has been operating for a minimum of five years. This standard helps ensure you work with a company who has experience managing a factoring portfolio and has some longevity. Obviously, the longer they have been in business the better.
2. Do they specialise in any industries?
Most larger debtor finance and factoring companies have a diverse enough client base that they can work in most industries. Smaller companies, although generalists as well, often specialise in certain industries.
Working with a financier who is comfortable with your industry has some advantages. They are familiar with any procedures or nuances specific to your industry. They are also familiar with your clients, which improves your chances of getting funded.
3. Do they offer good service? Can they provide references?
Service is a critical component of a debtor financing plan. You need to work with a company that responds to your financing requests quickly. Working with a company that has great rates but bad service is a recipe for certain failure. Unfortunately, it’s difficult for companies to measure the level of service of their prospective financiers. Every debtor finance company will tell you that they have great service.
The best way determine if the debtor financing company offers good service is to ask their clients. Ask the finance company to provide you with a few clients – ideally in your industry – as references. However, you should ask for references only after you have submitted an application and received a proposal. Asking for references prior to that stage is premature.
4. Are they a good fit for a company of your size?
Most debtor finance companies state that they can work with companies of various sizes. While this claim may be technically correct, most financiers have specific size preferences. It is best to avoid being their largest or smallest client.
One simple way to determine if they are a good fit for your business is to ask them about the size of their average client.
5. Is their pricing competitive?
Every debtor financing company uses its own specific pricing method. However, most use a variation of a service fee and a discount rate. The service fee is a one-time fee that is charged to every invoice. The discount rate is a separate fee that is applied only to the advanced funds. It’s calculated daily but charged monthly. This variation makes comparing proposals difficult.
One simple way to compare proposals is to use their rates to determine the financing cost of a 30- or 45-day invoice. A more sophisticated way is to determine the actual cost per dollar, though the previous method usually works fine. You can learn more about debtor financing costs and how rates work in a transaction.
6. How are they financed?
Few prospective clients ask this important question. Your ability to get financing is tied directly to the financier’s ability to finance your company. If they run out of funds, your company could experience serious problems. You should understand, and be comfortable with, how your financier is financed.
Debtor financing companies can be financed in a variety of ways, including investors, loans, etc. Enquire about how they are financed, the volume of invoices that they are financing, and what their actual capacity is. The answers to these questions will give you an idea of their financial capabilities. Obviously, it’s best to work with a company that is well financed.
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