Debtor finance

Need

Most businesses have to offer credit terms, usually of 30 days, in order to secure orders from customers. Current statistics show that these invoices can take up to 60 days to be paid. This delay reduces essential cash flow and restricts the growth of the business.

Security requirements

Security requirements vary, but traditionally focus on the value of the debtors ledger, supported by a pledge of specific assets as collateral and a charge or mortgage over the business, along with the personal guarantees of directors. Apart from some specialised lenders, real estate security is not taken. By focusing on the value and collectability of the accounts receivable ledger, most debtor finance credit lines will automatically increase in response to increases in sales, and provide ongoing working capital to fund the growth of the business. Typically the advance rate ranges from 70% of accounts receivable ledger value up to 90%. The remaining 30% to 10%, known as the 'retention' is released following receipt of payment of each invoice by the customer/debtor/buyer.

Types

Debtor finance products, by whatever name, essentially fall into two categories:

• Confidential: the customer or end-user is unaware of the funding being provided, often called 'invoice discounting',
• Disclosed: traditionally referred to as 'factoring', where invoices have a notice that warns the customer to pay the funds to the financier in settlement of the debt.

Export factoring is a highly specialised and selective form of factoring, and can provide non-recourse funding to exporters, paid at the time of shipment, and with solvency of the overseas importer underwritten by an overseas bank or institution.

Under each category there are a number of financiers, all with varying policies and guidelines regarding their procedures, security, pricing and target markets. There are providers of import and export factoring, and their conditions vary widely.

Transaction structure

Most debtor financing transactions are structured to operationally resemble an asset-based loan. The client submits its accounts receivable ledger to the finance company. The finance company processes the ledger and remits the funds to the client's bank account. Lenders often finance a percentage of the ledger, commonly 80%–85%, and hold the rest as a reserve. The percentage of the ledger that is financed varies and is based on the industry and risk profile of the client.

The reserve is remitted to the client once the advances settle, when customers pay their invoices.

Terms of providers

A firm's eligibility to sell off its invoices by means of factoring is dependent on the terms of acceptance of the factor. These terms do vary from factor to factor. Most factors would consider the rate at which the firm realizes bad debts by checking the firms bad debts account while another could only consider the reputation of the firm. Most business that provide goods or services to other businesses on credit can qualify for debtor finance. Debtor finance is more difficult to place for contractors involved in the building industry, but there are some specialised providers that are comfortable with contract issues.

Growth

The use of debtor financing has grown strongly, as it has become more widely recognised as a valuable financing tool, supplementing or replacing traditional overdrafts or fixed-limit business loans. Internationally, debtor finance business has grown from €40 billion in 1978 to over €580 billion in 2003, provided by more than 1,000 companies, most of whom are associated with international banks. This volume is greater than the business written each year in leasing.

References

References

1. "Glossary: Debtor financing definition".