Does your company have a strong balance sheet and positive profits, but limited access to cash because it’s tied up in client invoices? Ask any business owner and they will say the same thing: working capital is the lifeblood of a business. Imagine you could have access to 80% of your debtor book today to fund immediate growth. With debtor financing you can. Be warned though — this is not a facility for businesses in debt that are desperate for an injection of funds. It’s a means for companies to access the cash owed them by clients.
Confidential ‘invoice discounting’, as debtor finance is often referred to, is aimed at growing, well managed and profitable concerns that have good debtor books. “It is widely used internationally, particularly in the US, Canada, Australia and the UK and the South African market has grown in excess of 20% year on year for the past three years,” says David Cory, head: debtor management, Nedbank Business Banking.
What is debtor finance?
Debtor financing is a system whereby a bank purchases a company’s debtor book, which details all the debts resulting from the supply of goods and services. Depending on the value of the book and expected growth of the company, as well as the company’s financial management and invoicing systems, up to 80% of the value of debts may be advanced. The balance is retained to cover contingencies such as returned goods or situations where an invoice is disputed or a customer defaults on payment. The outstanding percentage is paid to the business once the original invoice is settled in full.
There are a number of debtor financing products available, but the two main products will be either disclosed or non-disclosed. In non-disclosed invoice discounting, the client sells their debtors book to the bank, but this arrangement is not disclosed to the client’s own customers.
Who is debtor financing for?
There are three core categories of business owners who should consider debtor finance:
- Business owners who have products or services that are bought on credit or have funds tied up in unpaid sales invoices
- Business owners who need to raise additional working capital to finance growth
- Business owners whose cash flow prevents them from paying creditors promptly, and as a result lose early payment discounts or are charged with interest.
The purpose of debtor financing is to unlock value against an idle asset. If cash is locked up in invoices, a business is inhibited from taking on extra work because it takes money to develop and manufacture products.
This means the product is predominantly for businesses that are growing rapidly as well as businesses that don’t have strong balance sheets or security to offer for normal banking facilities. These could be companies that, due to past good performance, have secured significant contracts, but will require cash to fund their operations to fulfil their obligations under these contracts.
On average, the quality of debtors should be good, there should be a fair spread of debtors, with no single debtor constituting more than one third of the book, and all debtors should offer repeat business.
Cory describes debtor financing as ideal for companies that have a mismatch between their debtor and creditor payments. ”Debtor finance enables our clients to negotiate better supplier discounts, increase their profitability and grow their business,” he explains, adding that it typically excludes inter-company and associated debt, private individuals, foreign debt without insurance cover, debt over term (in excess of 120 days from invoice) and any debt that is subject to a legal dispute.
Overdraft facilities vs debtor finance
A debtor finance facility is similar to an overdraft, except that the limit is not fixed but is determined by the value of the debts owed to the business. Ask yourself the following questions to ascertain whether your business would be better off using debtor finance:
- Is the growth of your business hampered by insufficient capital?
- Is cash flow affected by delayed payments from debtors?
- Are you forced to grant more discounts to debtors to encourage early payment/settlement?
- Are you able to secure extended credit terms with your suppliers?
- Are you spending more time and resources on debt collection than on sales and business growth?
- Are you looking for a more flexible way of financing your business?
“Clients can use their debtors book to get an overdraft facility, but banks will only lend up to 25% or 30% of the value of that book,” explains Cory. “With an overdraft facility, the bank is carrying a higher risk. We can unlock up to 80% of the book through debtor financing because we assess each debtor and are generally assured of repayment on the book. If a company goes into liquidation and the book has been sold to a factor, those debts are paid before anything else is taken by the liquidator. Because we would have the proof of delivery and the invoice, the level of dispute is far less.”