What You Need to Know About Debtor Finance

Rob Kirkpatrick


With over 20 years experience in finance working both locally and abroad across a multitude of industries, Rob Kirkpatrick now specialises in arranging commercial finance for clients at Vantage. Here he lays out the benefits and potential drawbacks of debtor finance or invoice finance, a product which is currently underutilised in Australia when compared to say the USA and UK.

What is debtor finance and how does it work?

Basically, most companies that provide goods or services and raise invoices with normal payment terms, usually between 30-90 days, are able to get an advance on the monies owed. If your business has a long working capital cycle and is cash-hungry, then debtor finance could be a suitable option for keeping cash flowing.

What are the main benefits of debtor finance over, say, a traditional loan?

For companies that are growing fast, it allows them to access working capital a lot sooner. As a business grows with increasing sales, the invoice ledger grows accordingly and with Debtor Finance you’d be able to tap into that as a source of funds to help with working capital. It’s more flexible compared to a bank loan or an overdraft, which are usually limited by the amount of attached security. It gives the company better control over its cash flow.

For example, if a company had a $200,000 overdraft limit and needed to access some additional funds, it wouldn’t be able to go above that. But if it had $400,000 in debtors, then with debtor finance it would potentially have access to about $320,000.

I feel that one of the hidden benefits is that debtor finance enforces better behaviours within a business – better credit control. Knowing that they’re bound by certain requirements of the financier, Clients tend to pay more attention to their paperwork, their invoicing and their collections, rather than just doing the work, raising an invoice and leaving it at that, hoping that their customer will pay on the due date.

‘ As a business grows with increasing sales, the invoice ledger grows accordingly and with Debtor Finance you’d be able to tap into that as a source of funds to help with working capital. ‘

What industries are best suited to debtor finance?

Typically debtor finance suits those businesses who have a long lead time between purchasing their inputs and the final invoice when the sale is completed. Industries such as transport, manufacturing, wholesale businesses and the fashion industry are good examples.

Likewise, not all industries or businesses are necessarily suited to debtor finance. Sometimes the make up of the ledgers just won’t suit such as when there are certain contractual obligations in the work being done. So at a fairly early stage in the process when a finance company is looking to fund the ledger, they will review it and understand the nature of the work etc. If it’s unsuitable, it won’t proceed.

What’s the difference between ‘invoice finance’ and ‘cash flow finance’?

Invoice (or debtor) finance is specifically where you are funding invoices. A funder advances a percentage of money against an invoice that will be paid at a later date. It could be one single invoice or a whole ledger where there may be multiple different invoices with 20, 30 or 40 different customers and millions of dollars worth of invoices outstanding. That’s invoice financing.

Cash flow finance is a more collective description of any type of finance that is helping with the cash flow in a business. That includes debtor finance, but also includes trade finance (for importing/exporting), supply chain finance or even cash flow lending, which is where a financier can lend money based on evidence of your previous and likely future maintainable revenue.

As an example of supply chain finance, take a business which has lots of high-value contract work with local councils – who in turn pay fifteen days from invoice. The business can’t do debtor finance because of the contractual clauses and since it gets paid pretty so quickly after raising an invoice, there’s really no point. However, the raw materials might need to be purchased 3 months in advance before they can even commence the work. In this case, a supply chain finance facility could be a useful option.

Do a business’ customers have an impact on applying for debtor finance?

They certainly can do. If you have local or state governments or Blue Chip companies as your clients then finance companies would generally be happy to lend because a payment dispute is unlikely. Whereas if your client base consisted of lots of small businesses and hundreds of low-value invoices, the funder might not want to lend or at the very least would charge a considerable fee to manage and handle that volume of invoices.

What makes debtor finance so useful in a business turnaround?

We’ve had quite a bit of success in our client turnarounds when implementing an invoice finance or debtor finance facility. Up until then, they may have relied on an overdraft for their working capital and had been restricted by that. But debtor finance is one way we can quickly release cash back into the business to allow management to make the necessary changes, fix up any problems in the short-term and get it back on track as soon as possible.

‘ We’ve had quite a bit of success in our client turnarounds when implementing an invoice finance or debtor finance facility. Up until then, they may have relied on an overdraft for their working capital and had been restricted by that. ‘

A recent example of this was a client who was with one of the banks. They had an overdraft facility limit of $500,000, but because the business had been underperforming it fell outside of credit policy in terms of risk rating so the bank wasn’t able to lend any more than that.  However, our client had a good Debtors ledger of about $1.5 million which, once financed, meant they could release up to $1.2 million. That company desperately needed the cash to pay suppliers, so we took it to another funder, refinanced it and the freed up working capital allowed us to make the long term changes that it needed to stabilise and get back on track.

Who offers debtor finance?

In Australia, we’re still some way behind the USA and the UK. Locally most banks used to offer debtor finance but now there are only two main banks plus a couple of other regional banks. However, there’s a bigger non-bank secondary market for debtor finance with quite a range of funders in this group including specialist debtor financiers, some of whom have a greater risk appetite.

Going direct to a lender or a commercial broker to discuss debtor finance is certainly an option, however, it’s also well worth seeking additional financial advice beforehand to ensure the approach and the potential lender will actually resolve the underlying cash flow issues and not end up with a product that is unsuitable.

Are there any potential issues with debtor finance?

The main issue is with people not paying enough attention to it. It’s not something that you can put in place and forget about. You need to manage debtor finance and there is a bit of compliance that needs to be maintained which I mentioned earlier. In a worst-case scenario, a business could suddenly run out of cash completely, because the debtor financier finds all debtors have not been managed properly and are all older than 90 days so it cannot advance any more funds. Ongoing credit control really matters to ensure a company won’t wind up starved of cash.

Another risk can be in a declining market. A business which might have $500,000 worth of invoices today, next month might only have $250,000. That would mean a declining ledger which can catch up with a business if they overspend or are not keeping track of it.

‘ The main issue is with people not paying enough attention to it. It’s not something that you can put in place and forget about.’ 

It’s also important to note that even if a company does have debtor finance in place, the lender might be limited by its own covenants as to what it can lend or what it can advance. So if the business changes the type of work it does or changes the terms with its clients, this may no longer be in line with what the funder originally agreed to and can have some impact.

It’s also worth being aware that almost all funders are required to do audits or independent checks with a borrower’s customers to ensure all information is accurate. This level of review will depend on the specific lender.

What’s the difference between confidential debtor finance and disclosed debtor finance?

A confidential facility is offered where it is deemed that there is low risk in a business. A lender will assess the ledger and let’s say its clients are all government or high profile businesses, plus the business has been operating for a good number of years, is well run, with very capable management and it’s consistently profitable. In that case, it is likely to have a confidential facility. The lender will register its security and advance the money, but the customers won’t know of the lender’s involvement. That’s a confidential facility.

Whereas a disclosed debtor finance facility will have noted on all invoices that the debt has been assigned to XYZ finance company. The customers will also know this because at the very outset they all acknowledge to the finance company that the debt is due and assign the debt to the finance company. That way the finance company can ensure security over the invoices that they’re lending against.

What are the terms and costs of debtor finance?

Typically anything that’s been invoiced and is up to 90-days old, can be funded. Costs vary from funder to funder and the rates, fees and charges all vary depending on the risk and type of facility offered by the funder.

For example, two different businesses in the same industry might get very different pricing for a whole range of reasons: different risk, size of the ledger, the amount of work expected etc. One company that has been through a few troubles might find their finance more expensive and have more rigorous checks around the process than their competitor.

Costs on the very low-risk end for a large corporation could be similar to a secured overdraft from a bank, but once you enter the second-tier lending territory or non-bank lending territory and smaller businesses, it can become more expensive. It could be a base rate plus an applied margin or simply a flat fee per invoice.

The important thing is not to always get fixated on the rate, rather focus on the solution. Sometimes a lender’s pricing can look expensive when it’s annualised. But what solution is it giving your business? Is it giving you access to working capital that you wouldn’t have otherwise? Does it allow the business to engage in new, more profitable opportunities? Could it save your business? And so on… Interest rates are very important, but they’re not the only factor to consider.

This article is general in nature and is not to be taken as financial advice. You should consider seeking independent legal, financial, taxation or other advice to check how information relates to your unique circumstances. Vantage Performance is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly.

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