Summary: Debtor financing is an umbrella term for products that finance accounts receivable. The most common debtor finance solutions are invoice financing and invoice discounting.
Invoice financing and discounting are used by companies that offer 30- to 60-day terms to customers but have problems waiting for payments. It works by funding slow-paying invoices, which improves your cash flow and provides funds to pay for business expenses. In this article, we cover the following:
- Do you provide 30-day payment terms to clients?
- How does debtor financing work?
- Benefits of debtor financing
- Qualification requirements
- How much does it cost?
1. Do you provide payment terms to clients?
Most small businesses that sell products and services to large businesses must offer their clients net 30- to 60-day payment terms. In most cases, you have little choice in the matter. Your company must offer these terms to retain clients. Otherwise, clients could decide to work with a competitor willing to provide the payment terms they request.
Offering payment terms can create cash flow problems, especially for small and mid-sized companies that don’t have a cash reserve. These companies typically can’t afford to wait 30 to 60 days to get paid. They need funds to cover essential business expenses, such as payroll and supplier costs.
2. How does debtor financing work?
Debtor finance improves cash flow and mitigates problems created by slow-paying invoices. It works by financing your accounts receivable ledger, which provides immediate funds for business expenses.
The transaction structure varies based on the type of debtor finance solution you decide to use. The most common options are invoice financing and invoice discounting.
a) Invoice financing
Invoice financing, also known as invoice factoring, allows companies to finance individual invoices. This structure is suited for small and medium-sized enterprises. It allows SMEs to finance their whole ledger, or just a portion.
Transactions are typically financed in two instalments. The first instalment covers 70% – 85% of the invoice’s value. It is deposited into your bank account soon after the debtor finance company processes the invoice.
The remaining 15% – 30%, less the invoice financing fees, is deposited once the customer pays the invoice in full. This payment settles the transaction. The following diagram shows how the transactions work:
The debtor finance company also helps manage credit and collections as part of its services. Invoice factoring works best for small companies that don’t have established credit and collections departments. You can learn more by reading “What is Invoice Financing? How Does it Work?“
b) Invoice discounting
Invoice discounting lines operate like revolving financing lines. Instead of managing individual invoices, the client finances a batch of invoices. The client receives 70% – 85% of the total value of the eligible invoices as available funds.
The line is adjusted regularly as your customers pay their invoices and your company raises new ones. Since the invoice discount company does not manage detailed invoice information, they do not handle collections tasks. Instead, the client manages these tasks.
Invoice discounting lines are better suited for larger companies that have established credit controls and collections procedures. You can learn more by reading “What is Invoice Discounting?“
3. Advantages of debtor finance
A well-implemented debtor financing programme can provide a number of benefits for small business owners. These include the following.
a) Improved cash flow
The most important benefit of debtor finance is that your cash flow improves, often quickly. This improvement provides financial stability, which is important for any business.
b) Flexible growth
Debtor finance lines are adaptive by nature. The line can grow with your revenues as long as you work with high-quality clients and operate a well-run business.
c) Simple qualification requirements
Debtor financing programs have simple qualification requirements. The most important requirement is to operate a business that works with creditworthy clients. Keep in mind that invoice financing has simpler requirements than invoice discounting because it is intended for smaller businesses.
4. Do you qualify for debtor financing?
One advantage of debtor financing is its simple qualification requirements, especially when compared to overdrafts, business loans, and other products. Generally, your business must be well organized, have good customers, and be free of major legal and tax problems.
To qualify for debtor financing, your company must:
- Be well-managed
- Have an ACN or ABN
- Have business clients with good credit
- Have a profit margin above 15%
- Not have its invoices pledged as security
5. Costs
The cost of debtor financing is determined by the size of the financing facility, the credit quality of the invoices, the client’s industry, and the general risk characteristics of the account.
Most invoice financing lines have an administration cost for every invoice and an interest rate for the utilised funds. Invoice discounting lines have a similar structure. However, they are less expensive than invoice financing lines due to their larger size.
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