Understanding is the Key with Debtor Finance

Posted by Neil Tunstall on 28 February 2014

Slower paying debtors and growing debtors are a constant concern for the majority of the SMEs that I work with. Strategies such as Debtor Finance, Trade Credit Insurance and Credit management are all tools that can assist if used pro-actively.  The situation is also greatly impacted by the lack of real support from their current financial partners and advisers who tend to think in traditional terms such as the use of secured overdrafts to fund working capital which is fine as long as there is sufficient security to support but is not the right option when the needs of the business outstrip the available security. When a business has slow paying debtors coupled with a growing level of sales it can be a recipe for disaster if not addressed early enough.
This can manifest itself in many ways but most noticeably through excesses in bank facilities such as overdrafts which can lead to calls for additional security, greater scrutiny from lenders, difficulty meeting normal commitments like payroll etc. The difficulty for many businesses is that they are growing well but their working capital is tied up in their debtors and their current structure does not allow them the flexibility to grow in a sustainable way.

Debtor Finance can be a part of the solution for many companies but it needs to be a part of an overall strategy which is aimed at improving the company’s cash flow. It is my belief that where possible any bricks and mortar security should be used for the funding of longer term requirements whilst the receivables should be considered to provide additional working capital capacity. In many cases the level of potential working capital that can be released from entering into a Debtor Finance structure equates to some 2 to 2.5 times the quantum of a secured overdraft which if used correctly would be of significant importance.

There is however little point in simply replacing debt with debt and the structure should look to remove some or all of the hard core component of any overdraft by amortizing debt over a longer term. This is critical if the Facility is to achieve the level of flexibility to regularize creditors, reduce Tax Liabilities and provide sufficient working capital to grow the company in an effective manner.
When considering structures such as Debtor Finance the business owners should also consider the following:

 Will this provide the capacity to renegotiate our supplier terms? (In many cases the additional working capital delivered can result in significant discounts.)

  • Will the facility enable us to reduce offering settlement discounts to Debtors
  • Will the use of debtor Finance create an opportunity to utilize our available security more efficient by refinancing any hard core overdraft and amortizing it over a term? Alternatively does it represent an opportunity to utilize the security to fund longer term working capital needs such as Stock or Trade Finance or Stock.
  • Does the facility create an opportunity to fund additional sales or open new markets
  • Will utilizing a Debtor Finance facility enable us to meet our Taxation obligations as they fall due rather than enter into expensive repayment arrangements.
  • Should Debtor Finance be considered in conjunction with Trade Credit Insurance or credit management to ensure that Collections are made in a timely manner?
  • Does the use of Debtor Finance create the opportunity to source new local or overseas suppliers
  • Does the use of Debtor Finance provide an opportunity for us to free up our security for succession planning or wealth creation.
  • For me the most important thing is to understand the key working capital drivers that each client that I deal with as every client is unique. It is critical to fully understand this and look for solutions that will assist in a meaningful way by adding value. I have seen too many clients who have simply taken options which do not address their hard core issues.

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