How Does Debtor Finance Work?
Finances Financial Planning

How Does Debtor Finance Work?

A generic term for products that fund a company by financing its invoices is debtor finance. The reason behind the growing popularity of debtor finance is the opportunity it offers small businesses and startups to grow their operations without the need for working capital. You get to finance slow-paying invoices, thus enabling you to have enough funds for current company expenses.

Furthermore, invoice factoring is predominantly used by small companies with cash flow problems. If your considering debtor finance as a solution to your company’s financial difficulties, here is what you need to know in order to put this method of financing into practice.

Setting up your account – the due diligence process

Setting up invoice factoring and/or invoice discounting accounts begins with the debtor financing company deciding to instigate a due diligence process. The finance company’s reviews depend on the following factors: organization of the business, their clients’ commercial credit rating, no liens on invoices, the financial statements, and the company’s credit and collections procedures.

The creditworthiness of your clients is critical for the success of the transaction. Debtor finance companies can finance only those invoices due to commercial clients that have good payment histories. The due diligence process usually takes a day or two for factoring transactions. The process takes longer for invoice discounting and more complex transactions.

The above list is a general list of items. The actual process varies by client. Note that the due diligence process to set up an invoice factoring account is usually faster and more flexible than the process to set up an invoice discounting account.

Debtor notifications

Customer notifications processes vary by product. In the case of invoice factoring, your customers receive a letter informing them that the debtor finance company is working with you and funding your invoices. The letter also advises them of the new address to remit payments.

Notifications for invoice discounting customers may also vary. For the most common disclosed invoice discounting lines, your customers receive a warning alerting them of the new payment address and subsequent procedures. If your invoice discounting line is confidential, the customer could get a payment address letter, but the letter won’t have any mention of the debtor finance company.

Verifying an invoice

In general, invoices are not verified when they are funded as part of an invoice discounting line. The only exceptions are invoices that exceed a certain amount. Furthermore, invoices are sometimes verified when they are funded as an integral part of an invoice factoring line.

The verification process indicates to the financier that their invoices are: free of disputes, accurate, and due in less than two months’ time. The verification process is carried out over the phone, through e-mail correspondence or fax.

Funding your account

In practice, account founding varies by product. If you have an invoice factoring facility, your company submits a detailed report outlining each invoice that needs financing. The invoice factoring company processes these reports, ledgers the invoices and remits the funds to your bank account. As each client pays, invoices are settled individually. If you find this process too complicated, then consult experts from companies like Classic Funding Group to help you understand how invoices get paid. 

The advance for each factored invoice ranges from 80% to 85%. The remaining 15% to 20% is deposited to your account, fewer fees, as soon as your client pays the invoice. To fund an invoice discounting account, you have to submit a report that outlines the aggregate values of the invoices you want to finance.

Depending on the way your account is set up, the report may need to break down amounts by the debtor of each account. Once the report is processed, the advance is deposited to the benefactor’s bank account. The advance ranges from 80% to 85% of the total value of the invoices.

The line operates as a revolving facility. When you receive a payment from a customer, they are posted against the outstanding financed amount, thus reducing it. The line increases, on the other hand, when you raise new invoices and submit them for financing. Excess reserves are returned as needed during this process.

Main benefits of debtor financing

A well-implemented financing program comes with numerous advantages for small business owners. The most important benefit is that your cash flow improves, often quickly. This improvement provides financial stability, which is important for any business.

Your company can extend payment terms to clients without worrying about potential cash flow problems. Such a possibility is important at times when you are unwilling or unable to extend terms in the past because you’re low on cash.

Finally, you need to understand that a financing facility is flexible, as it is tied to your sales. The facility will increase as sales grow. Debtor financing is an ideal source of funding for companies who wish to grow quickly.

Although debtor financing seems complicated at first sight, once you realize its benefits, you will use it extensively to finance your firm. If you own a small business, then don’t hesitate to integrate debtor financing into your daily operations.

Image source: Pexels.com

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