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A Guide to Debtor Finance/Factoring

Business Loan Articles > Article: A Guide to Debtor Finance/Factoring

Debtor financing, also known as invoice discounting, invoice factoring, partnership factoring, disclosed invoice discounting, or undisclosed invoice discounting is a type of financing based on the value of a business' accounts receivable ledger. If a business extends credit to its customers to purchase goods and services, debtor financing enables the company to leverage against the clients' balance owed to receive short term financing. In short, the debt is considered a business asset that the company can borrow against as collateral.

Accounts receivable are frequently one of a growing company's biggest and most valuable assets. Debtor financing allows a company to access the money owed to them by customers, enabling the business to grow more rapidly. While debtor financing is a great alternative to overdraft accounts for growing companies, this type of financing is not appropriate for financially unstable firms.

Why would a business need debtor financing?
Many businesses must extend a minimum of 30 days credit to clients in order to receive orders. These invoices frequently take up to 60 days to be repaid, typing up a company's cash flow and inhibiting the business' growth.

How much can I borrow through debtor financing?
Many lenders allow businesses to borrow up to 100% of the value of the invoice, while other cap the limit at 80%. As a general rule of thumb, debtor financing becomes cost-effective when the value of the invoices exceeds $100,000.

How quickly can I get funding?
Most lenders will make funds available to the borrower on the day the customer invoice is created and provide the business with 80% of the value of the invoice. When the customer pays the balance, the remaining 20% is paid to the business (minus the lender's charges).

What types of charges are associated with debtor finance?
Lenders will generally assess three different charges to debtor finance recipients:

  • Service fee - a fee assessed based on the value of the invoices being factored
  • Application fee - a charge based on the value of the invoices being factored
  • Interest charges - assessed at a given rate based on the value of the funds drawn down

Some lenders and debtor financing companies will also assess minimum terms, exit fees, notice periods, and audit requirements upon borrowers. All of these terms and conditions must be understood fully before the borrower enters into an agreement with the lender.

What can debtor financing be used for?
Borrowers can use debtor financing in a number of ways. Most commonly, debtor financing is available for:

  • All of the business' customers
  • A specific number of selected customers
  • Single invoices
  • Services provided
  • Exports
  • Progress payments such as construction loans

Do I have to provide collateral?
No. Debtor financing is secured by the value of the invoice, so no property or assets are required as security for the money.

Is debtor financing available for start up companies?
Yes; however the company must have invoices in order to be eligible. Also, debtor financing is not cost-effective until the value of the invoices being factored reaches a certain amount (generally $100,000), so debtor financing may not be appropriate for all start ups.

Do customers know that I'm using debtor financing?
Whether the customer knows that debtor financing is being leveraged against his or her account depends on the type of debtor finance being used. Undisclosed invoice discounting is kept confidential and customers will not know the invoices are being factored. Disclosed debtor financing, also known as factoring, makes the customer aware the invoice is being factored. The invoice typically includes a statement notifying the customer must pay funds to the lender to settle the debt. The strength of the business, industry type, and customer base of a company will affect whether the debtor financing is disclosed or undisclosed.

Can I increase the amount of funding available through debtor financing programs?
Most business' debtor finance credit lines increase naturally as a result of increased sales providing the company with a continuous stream of capital. This enables new and growing businesses to fund their growth without taking on unnecessary debt.

How can I offset the costs of debtor financing?
Most companies offset the cost of debtor financing in one of the following ways:

  • Increasing sales volume through growth
  • Offering suppliers discounts for paying cash or paying within 7 days
  • Passing the debtor financing expenses on to the client
  • Through tax advantages

In many cases, the costs of debtor financing programs are compensated by increased profits and improved cash flow.

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