Whether it’s to improve cash flow, manage a sluggish sales period or realise growth potential, businesses will often need to seek external forms of funding. There are many finance options available, and it can be difficult, as a business owner, to know which way to go.
Debtor finance (also known as invoice finance) is often an attractive option for high-growth businesses. This form of funding enables a business to access funds tied up in its outstanding B2B invoices. And it’s a solution that is growing in popularity, with reports indicating more and more businesses are seeking this form of finance.
Start researching debtor finance and you’ll come across a range of terms, definitions and products, including invoice funding, invoice factoring, invoice discounting, and confidential and disclosed products. So, what is debtor finance, how does it work and how can it benefit your business? In this article, we explore these forms of financing, some of the products available and how they help businesses in a range of industries.
How debtor finance works
As any business owner knows, maintaining cash flow is the most powerful tool for starting, managing and growing your business. Strong, steady cash flow puts you in a better position to:
- cultivate good relationships with your suppliers, as you’ll always have the funds to pay them on time
- quickly take advantage of opportunities to invest in new products or services and stay ahead of competitors
- weather financial storms when business is quiet, or you encounter supply chain issues.
But if your customers are slow to pay, that cash flow can get blocked. That’s where debtor finance products can help, by giving you access to funds tied up in your business’s outstanding invoices.
Sam Ralton, Octet’s Director of Working Capital Solutions, explains. “There are a number of terms used to describe these products. Invoice finance, receivables finance, debtor finance — they all cover essentially the same broad offering, which considers the receivables ledger or the invoices that are outstanding in a business and provide funding against those.”
Invoice factoring and invoice discounting are two ways to finance outstanding receivables to keep money flowing. Let’s explore these options.
What is invoice factoring?
With a debtor finance facility known as invoice factoring, you effectively sell your accounts receivable to a financier. In exchange, they give you an agreed percentage (often up to 85%) of the value of the invoices upfront — quickly and easily.
From there, the financier becomes responsible for collecting and processing payments from your clients. Once they’ve collected payment, they pass the rest of the money onto you, minus a small fee. Here are a few things to keep in mind.
- Because you pass the responsibility of collecting payment to the financier, invoice factoring can potentially save you bookkeeping fees and staff time. The trade-off is that you forfeit some control over your day-to-day operations.
- Invoice factoring companies generally help with sales ledger management by allocating payments, and sending statements and reminder letters. The associated fees are therefore higher than for some other debtor finance services because the financier does more work.
- Your customers will know you’re using a financing facility because they need to deal with your financier.
What is invoice discounting?
Invoice discounting (also known as receivables discounting) is similar to invoice factoring but with one key difference. With invoice discounting, the financier doesn’t take on the responsibility of collecting the debt. Instead, that stays with you. This is what you need to know.
- With invoice discounting, you manage your sales ledger, which means you keep control of a significant aspect of your business.
- Rather than operating on an invoice-by-invoice basis, invoice discounting is usually based upon your ledger balance as a whole. This lets you smooth out any cash flow fluctuations you may have over the period.
- Invoice discounting also lets you keep your funding confidential from your clients. They won’t know that you’re using a financier.
Whichever method you choose, both invoice factoring and invoice discounting let you tap into your accounts receivables to keep your cash flowing and your business growing.
The evolution of factoring and discounting
Sam says the term factoring is used less frequently these days. “In the early days, invoice factoring was fairly intrusive. Businesses found they had to hand in every invoice, and the financier would chase up the debts.”
Today, reputable finance providers like Octet offer more tailored debtor finance solutions and collaborative partnerships. “We have supply chain finance managers that are constantly in discussions with clients, looking for any cash flow issues or opportunities that may arise and assisting with these.”
“We have also seen the emergence of hybrid type disclosed invoice facilities that enable the business and financier to work in partnership. These allow the business to retain their receivables collections, with the financier simply sending monthly statements in support. It’s a lighter version of disclosed invoice finance and reflective of the progression of the product over the years.”
What’s the difference between confidential and disclosed debtor financing?
A confidential debtor facility is where your customers don’t know a third-party financier is involved. You’re under no obligation to tell your debtors (in other words, your customers) that you’re using debtor finance, and the financier does not contact them on your behalf.
It generally attracts lower fees as the financier can’t put their own debtor management strategies in place, and your clients don’t know they’re involved.
With disclosed invoice discounting, all parties know and agree to the financing facility. Your invoices will need to include communication regarding the third-party financier, who has the right to contact your customers to chase payments.
There are generally higher fees involved as this allows you to hand off debtor collection procedures to the financier and provides full visibility for all parties involved.
How does confidential invoice discounting work?
Once your facility has been approved and set up, you’ll need to communicate a change in bank details to your debtors. The new account is held in trust by the financier.
You then upload invoices into the financier’s system at the same time you send them to your customers. The financier then transfers up to 85% of the invoice value directly to your bank account, often less than 24 hours later. Then, once your customers pay the invoice into the trust bank account, the financier transfers the balance to you, minus their agreed fees.
This process means you can keep your existing accounts payable procedures in place. Chasing up late payers remains your responsibility, but that also means you maintain control of that vital relationship.
How does disclosed invoice discounting work?
Once you’ve been approved for a disclosed facility, the financier will get in touch with each of your customers as you upload their invoices into the system. Your customers will need to pay the invoices into a bank account held in trust by the financier, as they would with a confidential facility. However, they will know that it isn’t your business’ bank account.
Just as with confidential invoice discounting, you’ll receive up to 85% of the invoice value within as little as 24 hours of uploading the invoice into the system. Then the financier will liaise with your customers to collect payment. Once the customers have paid, the balance of the invoice value will be transferred to your bank account, minus fees.
Which is best: confidential or disclosed?
The best choice for your business generally depends on two factors:
- Your business’ current credit rating. If your business has a strong credit rating, you may be eligible for confidential invoice discounting.
- How much control you want to have. Some businesses prefer to keep debtor management as part of their client relationships, while others are happy to hand it off to a third party.
Businesses are becoming more comfortable handing over control of their debtor management and customers are becoming increasingly used to a third party being involved. Engaging a financier to access your receivables means you’re being smart about your cash flow. Accessing one of your biggest business assets enables you to grow faster, which is better for you, your suppliers and your debtors.
The advantages of debtor finance
Why would a business choose debtor finance over traditional forms of finance, such as a bank loan? Sam explains.
“Banks focus on ‘bricks and mortar’ assets and are very keen on taking property security and effectively offering a mortgage when it comes to business lending,” he says, adding that this is one of the major disadvantages of traditional bank finance. “That’s because not all businesses have sufficient property assets to use as collateral, nor do they generally want to use their director’s personal assets as security.
“Debtor finance is effectively funding against the biggest asset in most businesses — the receivables ledger, which is cash owed to a business by its debtors or customers. That ledger typically sits there as an asset, not doing anything until paid pursuant to agreed payment terms. Because a debtor finance facility actually uses that asset as security for funding, it removes the need for directors or owners having to put up property or other security.”
Sam says banks can also be slow-moving, taking more than six months to approve applications for finance applications. In the meantime, businesses can miss out on opportunities or fall deeper into cash flow woes. Debtor finance applications, on the other hand, can be approved within a matter of weeks.
Is debtor finance right for you?
When considering a debtor financing product or facility for your business, there are a few things to keep in mind. Like any form of finance, there are costs involved. These will vary depending on the provider, the type of product, the financier’s workload and whether it’s a confidential or disclosed facility.
“Generally, there’s an interest component on the borrowed amounts and a service fee,” says Sam. “There’s a bit more work involved in disclosed debtor finance because the financier is constantly reviewing the ledgers.
“But businesses using a debtor finance facility are probably only paying slightly more than they would for a standard mortgage or an overdraft facility.”
The suitability of this type of facility depends on your business and its needs. Sam understands some businesses have had negative experiences with debtor finance, but that’s often the result of choosing the wrong financier or using a product not suited to the business.
Business owners might also be concerned about handing over control of their accounts receivable or ledger management to a third-party financier. This is why choosing the right finance partner is vital.
Look for an invoice financier with a solid reputation, says Sam. “You need to have comfort in the security of the business that’s providing funding and partner with someone that’s going to last.”
Some finance companies offer quick fixes, which Sam advises businesses to avoid.
“There are a lot of companies that do short-term loans at higher interest rates, fairly quickly, but it’s not going to help a business become sustainable in the long term. We’ve seen business owners take up short-term loans and then realise how expensive they are. My advice is to look for a financier that is going to be a long-term partner and understands the overall business strategy and success measures.”
Is your business ready for a debtor finance solution?
There are several reasons why you might be considering debtor finance for your business. Due to your payment terms, you might be experiencing cash flow issues, find that you can’t restock until invoices are paid, or simply want faster-moving cash flow to open up growth opportunities.
“Most businesses that speak to Octet about debtor finance have high supply costs,” says Sam. “Let’s take the example of a labour-hire company, which will raise an invoice after the work has occurred. But they must pay staff before their invoices are paid.”
Debtor finance allows these businesses to fund their workforces without having to wait for debtors to pay. This is particularly helpful in the growth stage of a business.
“These facilities grow with the business because as you raise more invoices, you can generally access more funding,” Sam says. “And as a business winds down, the facility pays itself out so the directors aren’t left with a large hole that takes away their property.”
A fast-growing business was exactly the opportunity facing a NSW-based labour-hire company that recently sought Octet’s help. The business grew from a humble startup to turning over $30 million in just seven years, and it had outgrown its bank, which just couldn’t keep up with its need for flexible and fast funding. The business didn’t want to turn away new customers but it just didn’t have the cash flow to take on new business and pay its debtors on time. Octet’s debtor finance solution filled that gap.
A Western Australian-based network and telecommunications parts wholesaler was also outgrowing its existing funding arrangement when it turned to Octet. The business was growing fast, but its available capital couldn’t support that growth. Octet provided a notified (disclosed) invoice discounting line with a $600,000 funding limit. This gave the business a line of credit where it could access up to 85% of the value of its invoices as cash within 24 hours of customer sales.
Octet, the experts in debtor finance
Octet’s Debtor Finance facility lets you convert up to 85% of your unpaid invoices to cash within 24 hours.
But is it the right funding choice for you? It might be a good fit if your business:
- offers longer payment terms to customers
- is seasonal
- contracts to large corporations that can set their own (longer-than-average) payment terms.
Debtor finance gives you the cash flow to pay suppliers, buy equipment or expand your business. Because it’s based on your outstanding ledger balance, the amount of finance you have available generally grows as your business does.
Unlike many other types of finance, you don’t need to provide security like property. So, if you’re a business owner who doesn’t have personal property, or your assets don’t have enough available equity, debtor finance may be your best option. It’s flexible enough that you can use it as your primary source of funding, or only for top-up funds.
Octet’s Debtor Finance is available to businesses ranging from newer companies to well-established ones. Ideally, we would like to see an annual turnover of at least $1 million, an outstanding invoice value of $100K+, with some demonstrated business trading history (but don’t hesitate to contact us anyway if you’re fast-growing and turning over $500,000 or more, as we may be able to help).
Discover more about debtor finance
Considering a debtor finance solution for your business? You’ll want to team up with a financier you can trust. The right solution for you will depend on factors like how big your business is, your assets and the funding amount you need to inject.
Octet has been providing working capital solutions, including debtor finance, since 2008. Talk to us today to discover how we can power your business growth.
Disclaimer: The following comments are only our views and should not be construed as advice. You should act using your own information and judgment. Although information has been obtained from and is based upon multiple sources the author believes to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute the author’s own judgment as at the date of publication and are subject to change without notice.
