What Accountants Should know about Debtor Finance
With financial regulations impacting Australian SMEs' access to bank funding, it's timely for accountants to take a fresh look at what funding alternatives, such as debtor finance, could offer their business clients.
SMEs need access to working capital to fund growth, so it's important accountants are across all options that might suit their clients' business situations.
Accountants are among SMEs' top three most trusted business advisers (according to a survey by Scottish Pacific of more than 500 Australian SMEs) so it's very likely that any business having funding issues will seek advice from their accountant.
One funding option not always considered by accountants is debtor finance, which in the past 25 years has become a mainstream funder of small to medium sized enterprises in the UK, US and Australia.
More than 4,500 Australian SMEs, with combined annual revenues of $65 billion, use debtor finance. Debtor and Invoice Finance Association of Australia and New Zealand (DIFA) figures show an estimated $7 billion in credit lines, up from $3 billion a decade ago.
Providers range from major banks to small regional independents. Larger specialist debtor financiers tend to offer the widest range of options, so they can tailor solutions to a business’ specific circumstances.
Debtor finance facilities best suit growing businesses in industries such as labour hire, manufacturing, wholesale trade, recruitment, transport and printing, who offer products or services to other businesses on normal trade credit terms. To give an idea of scale, Scottish Pacific funds qualifying businesses with annual sales turnover ranging from start-up to $200,000,000.
Here are 5 business situations in which debtor finance can assist:
1 High growth Debtor finance is an ideal solution for cash-hungry growth businesses, providing a line of credit that grows in tandem with turnover.
A debtor finance facility will pay for itself very quickly where a business with profits is turning away orders because there is no cash to fund growth.
A typical facility will advance 80 per cent of the value of receivables, so working capital of $400,000 would be available against a ledger of $500,000; $800,000 against a $1million ledger, and so on.
The key is to find the right fit for the business so finance arrangements support its current needs and enable it to grow without undue constraint. As the business grows, the debtor finance facility (unlike a typical business overdraft) automatically grows with it. Debtor finance is one of the few forms of finance with this flexibility.
2 Start-up venturesStart-ups often have limited funding options beyond re-mortgaging or asking friends and family to invest since traditional forms of finance rely heavily on past performance rather than future prospects.
Debtor finance provides new ventures with access to working capital that would otherwise be tied up in receivables for 30 to 60 days or more. It is a self-liquidating facility - instead of taking on additional debt, the business receives an advance on money it is already owed.
It can help grow the business through enhancing cash flow to fund staff, stock or capital expenditure. Unlike overdrafts, debtor finance does not generally require real estate security. It is a standalone facility that can sit beside other business borrowings (such as term loans and leasing). Unlike a bank loan there is generally no need to re-negotiate increased facilities, as available funding grows in proportion to sales.
3 Management buyouts/Mergers and acquisitionThe receivables ledger of the target business can be used in a debtor finance facility to generate funds to contribute towards the purchase price or to provide ongoing working capital.
4 TurnaroundA business with a sound turnaround plan can generate an immediate cash injection from the receivables ledger to buy time to fix problems: as long as the underlying business is strong, debtor finance can solve short-term cash flow problems caused by issues such as bad debt, loss of a major customer, productivity delay or machinery failure.
5 DivorceOften one partner gets the business and the other the house - meaning the house is no longer available to secure the business borrowings. Debtor finance can replace the borrowings that were secured by the house in these situations.