Debtor finance

Business owners often seek out methods to support their cash flow in order to get them through difficult times. A common cash flow support method for businesses is known as debtor finance.

What is debtor finance?

Debtor finance (a.k.a: ‘factoring’ or ‘accounts receivable finance’) is essentially a way for business owners to give themselves some breathing room (a.k.a: cash) from their outstanding debts so they can keep focusing on the rest of their business.

You may have come across the term ‘equity financing’, which involves sourcing money from within your business, while debtor financing involves sourcing it externally. You can learn more about the differences between debt and equity financing here.

How does it work?

If you choose to use debtor finance for your business, it would involve the following:

• A bank or other financial institution buys your business’ debts and takes a fee from them.
• The financial institution then gives you the cash amount and collects the debt on your business’ behalf.

It’s important to remember that while this process can allow you to continue running your business smoothly, it’s highly recommended that you seek out financial and legal advice before signing an agreement.

For context, it’s also a little like getting a secured business loan for buying an asset (such as new equipment or a business vehicle) – but in this case, you’d be securing your loan by using outstanding business debts as your ‘secured asset’.

What are the pros & cons of debtor finance?

Generally speaking, it can give businesses a steadier cash flow so they can more easily do the following types of things:

• Pay their supplies in a timely fashion.
• Offer extended payment terms to customers so they can increase sales.
• Increase their stock levels to cater for higher demand.
• Upgrade tools or equipment to create or sell more products or grow services.
• Avoid using personal assets to cover outstanding business debts.

However, some of the cons of debtor financing include

• Some banks may be less likely to lend to your business, especially if your business is relatively new.
• If the worst case scenario happens and your business fails, you would still need to repay your debts.
• Your credit rating could be negatively impacted if you don’t make your repayments on time.
• Your business may be better suited to other cashflow support methods such as operational cash flow or investment cash flow.

What’s invoice discounting?

This is a confidential process where a business can be provided with instant funds for most of their outstanding debts.

Essentially, as a business owner, you would apply for invoice discounting by applying for a business loan and use your unpaid debts as security. As mentioned earlier, this is similar to a secured business loan, which is a way some businesses choose to finance a commercial vehicle purchase.

It’s also important to remember with regards to invoice discounting, although you would be receiving a boost of cash from your lender, you would still be in control of dealing with your customers and fulfilling payments.

What’s invoice factoring?

This is similar to invoice discounting, but ‘factoring’ your invoices means you would be required to sell them to a factoring company, and your customers would be notified that a factoring organisation is in charge of collecting debts.

If you do choose to go ahead with invoice factoring, bear in mind that the factoring company you choose to work with will be liaising directly with your customers to collect outstanding debts. This means that you might want to consider a reputable company that has a wealth of experience in dealing with collecting debts.

Make sure you do lots of research on a factoring company before signing the dotted line with them, as in some cases, liability can fall on your business if debts aren’t paid.

What sort of businesses can use debtor finance?

There are quite a few businesses that might consider debtor financing listed below.

• Small businesses could struggle with getting paid on time, so having a way to get paid on time may help with planning and organising things for the weeks and months ahead.
• Bigger businesses may use debtor finance to help keep cash flow going and help ensure outstanding payments don’t get in the way of running business as usual.
• Seasonal businesses can struggle in off-seasons and downtimes, so debtor finance may allow them to bring payments forward so their operations don’t stall.

What kinds of things are worth considering when comparing providers?

Just as you would consider different factors when comparing personal loan providers, there are a few things to consider when you’re on the hunt for a business debt financier.

• Make sure the financier you’re considering is able to provide a suitable amount of money for your business. Some financiers cater to small businesses while others exclusively work with larger operations.
• Check to see whether or not they charge their fees in advance. Quite often these fees are very small, but they can vary depending on how financially secure your company is. For example, if your company’s credit rating isn’t crash-hot, then it’s possible that you could be charged with a slightly higher fee.
• In addition to that, find out whether the provider charges for any other additional fees such as transaction or exchange fees.
• And lastly, keep an eye out for their repayment policy, so you know what to do in case a customer doesn’t pay you on time.

What should I avoid when choosing a provider?

Unfortunately, there may be unlicenced providers which you may want to avoid. You can check this list of unlicensed companies, and learn how to check if a company is licensed here. At iSelect, we’ve partnered with Valiant to help make the process of securing financing easier and less complex.*

Valiant works with a range of well-known Australian banks and non-bank lenders, so you can count on them to help you choose a suitable provider.

Where can I compare options?

You can start here with us at iSelect, as we’ve partnered with Valiant to make the process of comparing and securing finance options for your business seamless and simple.* Click here to get started today.

Last updated: 6/12/2021