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Can debtor finance save your cashflow?

Debtor finance has been rated as one of the top three products to watch in 2011 and statistics are reinforcing its growing popularity among Australian SMEs as a cashflow saviour.

Debtor finance, also referred to as invoice discounting or factoring, operates by turning unpaid invoices into cash almost immediately. Unpaid invoices or receivables are sold to a discounter who converts 85% of the value of each invoice into cash within 24 hours. Once payment has been received on the invoice, the remaining 15%, less a service fee, is returned to the client.

According to the Institute for Factors and Discounters (IFD), the debtor finance industry has grown ten-fold in Australia over the last decade and factoring turnover reached its highest level yet, to almost $1 billion in turnover in the December 2010 quarter.

Reasons behind its growth include:

  • Bank lending can still be difficult to obtain and the traditional bank overdraft can be costly, timely to secure and may not meet cash requirements.
  • As economic conditions improve in 2011, businesses are requiring cash to fund growth.
  • Debtor finance doesn’t require real estate as collateral.
  • Brokers and accountants are educating businesses about the benefits of debtor finance.

When a business is growing or restructuring, cash is king and without it, businesses often struggle to stay afloat or, at the very worst, become insolvent. The number of business failures in Australia increased by 23% to 10,000 last year according to Dun & Bradstreet’s 2010 database.

A steady source of cashflow is a key ingredient to fund normal business operations and assist with growth, however cash is often tied up in invoices waiting for payment. In fact, receivables are often the largest asset on the balance sheet for small businesses.

Typically a business will allow 30 days for unpaid invoices to be paid, however businesses are waiting progressively longer. Dun & Bradstreet found that payment terms for businesses rose to 53 days from 50 days in the December 2010 quarter; 23 days longer than the usual 30-day payment period.

Traditionally businesses have relied on banks for credit, predominantly using a bank overdraft to access more cash. However, having to jump through hoops to get a bank loan can slow things down. As a result, businesses are increasingly turning to debtor finance to bridge the gap between receiving payment and paying expenses.

Debtor finance is also assisting business growth. ‘Expanding the empire’ is high on the agenda for many SMEs as Australia’s economy improves and many businesses witness the rising demand for their goods and services. At the same time, however, costs are consequently increasing to hire more staff or purchase more raw goods to meet increasing demands, placing more stress on cashflow.

Debtor finance grows in line with a business and is automatically able to increase the amount of finance available as sales increase, making it a highly suitable product for expanding businesses.

No real estate collateral needed

Debtor finance doesn’t require property as security, relying more on receivables and the quality of the debtor’s ledger. As a result there is less reliance on trading history, profitability and balance sheets.

In comparison, a bank overdraft or other loan products are generally required to be backed by property; often the director’s family home. More recently, the property market in Australia is seeing signs of uncertainty, which is in turn causing concern from the banks over credit limits.

This means many businesses, which were previously using a traditional overdraft secured against the equity in director’s homes, may be experiencing a shortfall in funding and need to look for alternative solutions to ensure their cashflow is sufficiently funded.

And for those businesses that do not have property to lend against or are unwilling to provide it as security, have found bank finance difficult to obtain.

Is debtor finance suitable for you?

While there are numerous benefits using debtor finance, it is important to note that it is not suitable for every business and situation, and you should consider your needs and suitability before proceeding.

Generally, businesses selling to a single large customer or selling under retention of title clauses or using ‘progress payments’ are not suitable for debtor finance. This typically includes construction and IT services. Fees are also marginally higher than real estate secured facilities, so they may not be suitable for certain low-margin businesses.

However, used prudently, a debtor finance facility can provide much needed liquidity for a range of purposes, particularly growth funding, or even supporting mergers and acquisitions, management buy-outs and succession planning. Debtor finance can also help when restructuring, which generally requires a reliable cashflow.

Debtor finance is particularly suitable for businesses that operate using account receivables, whether they are a wholesaler, manufacturer, distributor or in the service industry. The biggest users of debtor finance in the December 2010 quarter were wholesale traders at 34% of total receivables; followed by manufacturing at 21%; labour hire at 10% and transport and storage at 9%; and property and business services at 9% according to the IFD statistics.

Choose the right provider

Choosing the right lender is critical, as with many finance products. Ensure your provider is well established, sufficiently flexible and has a strong service history. Assess the experience levels of the staff managing your facility.

Also consider how quickly the lender will advance and remit funds to you, ensuring that it meets your requirements. Should you need access to funding quickly, it will be worth asking how quickly an application can be processed or your facility reviewed.

There is no doubt the use of debtor finance is on the rise. Its flexible, efficient and fast funding arrangement is resonating with an increasing number of small businesses. After all, you can survive a number of years without profit, but you will be lucky to last six months with a negative cashflow.

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Greg Charlwood

Greg Charlwood

Greg Charlwood is the managing director of Bibby Financial Services Australia, a global specialist provider of factoring and invoice discounting services for small and medium sized businesses.

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