How Does Debtor Finance Work?

A Step by Step Overview of Debtor Finance

Companies facing a cash-flow squeeze and slow-paying customers often sell their invoices or accounts receivable to specialised companies called factors. This is called debtor finance. In this article, we will go through a step by step overview of how you can use debtor finance.

Companies that use factoring like it because they get money quickly. Rather than waiting the usual 30 or 60 days for payment. After sending an invoice to a factoring firm, a business can have money in its hands within 24 to 48 hours.

Some businesses use Factoring Finance | Debtor Finance | Invoice Factoring to get started. Banks always focus on a business’s creditworthiness and real estate assets in considering whether to make a loan. Factors look at the financial soundness of a business’s customers. As a result, business with scant credit history may be able to sell their invoices.

Billions of dollars in accounts receivable flow through factors each year. Many of them specialise in particular industries such as trucking, construction or health care. Some companies use factoring finance to meet cash-flow needs as a stop-gap measure.

Other businesses prefer factoring to banks, which often factoring businesses require less paperwork than Banks. The same applies other outside investors, who may want a piece of the business and dilute the owner’s equity.

The factor advances most of the invoice amount — usually 70% to 90% — after checking out the credit-worthiness of the invoiced customer. When the invoice is paid, the factor remits the balance, minus a transaction (or factoring) fee – this is called a rebate.

Lets break that down step by step.

Step 1:

The fundamental thing to remember is that funding is secured with the business owners debtors ledger.

So our risk is not with the business owners but with the customers business owner.

Risk Management strategies are employed to assess the risk of non-payment by the customer.

If there is a positive outcome, the customer is approved and the business owner is notified.    

Step 2:

The business owner invoices their customer for goods or services that must have been provided or supplied. The customer is now the business’ debtor and owes money to the business on a specific due date as per the agreed terms.  The due date and the total sum payable form part of the invoice.  

Step 3:

The factor then performs an Invoice Verification with the customer.   Verifying the invoice amount is accurate and that the customer agrees that the amount is due on the date stipulated.

Step 4:

Only after a successful verification does the factor pay the agreed percentage (anywhere between 70 to 90% of the invoice) to the business owner, holding the balance in reserve. The business owner now has access to funds that would otherwise be locked up in the invoice.

Step 5:

On or before the due date, the factor receives the payment from the customer.  

Step 6:

The balance on the invoice that was held back by the factoring agent initially is paid to the business owner minus less any fees charged by the factor.  This is called the rebate.

With this kind of small business funding, the business owner has much more flexibility to assist with the cash flow management needs of the business.

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