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Understanding Debtor Financing

Debtor financing can provide a positive injection of cash into the business to help fund working capital and meet short-term growth needs, but it can be relatively expensive and is not suitable for all businesses. Bill Shew explains more about debtor financing and when to use it.

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In practice, debtor financing involves getting a bank or specialist lender to provide your business with a loan, which is secured against the outstanding receivables of the business. If you have particularly long credit terms (for example over 60 days) but need an immediate working capital, rather than waiting for customers to pay, then debtor financing can help.

Debtor financing provides an alternative way to fund the working capital of the business without using your personal assets or the fixed assets of the business as security.

It can be particularly useful for businesses without significant fixed assets (such as technology companies) who wish to fund short-term growth, as well as businesses looking to address short-term cash flow issues.

Debtor financing tends to be a more palatable option for business owners or for businesses in growth phase, where the owner does not wish to provide their home as security for the business. This is very relevant where the home is not owned by the individual at risk or, in those circumstances, where one business partner may own a home and the other doesn’t.

However, because debtor financing costs more in interest than other forms of funding, its use needs to be carefully considered. It is often used where all other forms of security have been exhausted or kept in reserve as an option when the business needs to fund rapid growth opportunities and lacks the working capital to capitalise on these.

It should be noted that debtor financing is not factoring. Factoring effectively outsources the debt collection process to a third party (the financier). With factoring, debtors are made aware that all debts have been assigned to the Factor and payment must be made to the Factor, rather than the business. This can have a significant impact on customer relationships. With debtor financing, subject to certain conditions that may exist within contracts, the customer may never know about your internal funding arrangements and will continue to pay you on the agreed terms.

Debtor financing has seen a resurgence within the financial industry as banks and other financiers have recognised the opportunity to provide businesses with new forms of cash flow lending and not rely purely on bricks and mortar as security.

Both banks and other subsidiary financiers (some specialising in debtor funding), provide this form of finance. In fact, most of the major banks now provide this service.

Debtor financing needs to be seen as another way of funding working capital. It’s important you consider whether it would make more sense to use your personal or fixed assets to do this. This will cost the business less, but you may decide this approach doesn’t suit your personal circumstances, or that you wish to keep your fixed assets available for other forms of security if needed. If you do decide that debtor financing is a viable funding option, there are some important points to bear in mind.

If your debtors book is strong and cash collections are within 45 days, then debtor financing will not provide any real additional funding benefit and will in fact cost the business through interest charges. Debtor financing has its benefits where customers are slow to pay over 60- to 90-plus days. But you need to be confident those customers will pay.

Debtor financing is not a way of replacing the cash flow from old or bad debtors. This source of finance is reliant on the ongoing performance of the business and the maintenance of a healthy debtors’ book. The larger and healthier your accounts receivable are the better your chance of getting this form of funding will be.

You need to be able to demonstrate the strength and longevity of your customer relationships and be prepared for the bank to interrogate these.

As with all loans, the bank will be looking for reassurance that it will recover its money and because the risk is higher with debtor financing, the interest charged is higher and the bank undertakes a more stringent due diligence process than it might when fixed assets are used as security.

If there are significant bad debts, questionable clients or old debts, then the financier will not lend against these sums and you need to recognise that you may be lent less than the book value of your debtors.

You should also be aware that this financing may be restricted if you have contracts with customers that have restrictive assignment clauses in those contracts. Many business owners enter into a contract with a key customer, or a number of customers, where the contract specifically states that neither the service nor the debt can be assigned. This will mean that you cannot use debtor financing with those customers.  

Debtor Financing Pros and Cons


•    Cash flow funding without securing over the assets of the owner or the business.

•    It is an invisible form of financing to customers; as long as the process is managed effectively the customer need not know.

•    Leaves fixed assets available for other forms of security if needed.


•    Higher interest charges than finance secured over assets.

•    Debtor financing had the stigma of ‘factoring’, but this is changing. Factoring was seen as a last financing resort for businesses with poor cash flow and on the edge of insolvency. Debtor funding is not the same and is coming into its own as an alternative form of funding.


Debtor Financing Questions

•    Have you considered using your personal or fixed assets to obtain short-term funding?

•    Are you happy to pay the higher interest rates associated with debtor financing?

•    Do any of your customer contracts have assignment clauses?

•    Do you have a strong client base and confidence that this will continue?

•    Are you prepared for the bank to conduct due diligence on your business?

•    Do you have a strategy for maximising the cash injection into your business?


* Bill Shew is a director of Business Owner Services with business advisers, Grant Thornton, Sydney. Visit www.grantthornton.com.au for more information.


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