I would consider debtor finance if it wasn’t so expensive. My business can’t afford it.”

This is a view often expressed by business owners and decision makers who don’t properly understand this type of finance and they are often taken aback by the response “Are you sure your business can afford not to do it ?”

In headline terms, debtor finance may not be the cheapest form of commercial finance available, but it’s important to properly understand the enabling role it can play in the development and growth of a business and the alternatives available, before reaching any conclusions about whether it costs too much.

Growing businesses are cash hungry, and without the availability of working capital to meet increasing staff and material costs, the danger is that profits that look good on paper can in reality be tied up in stock and debtors.  There is then insufficient cash available to meet wages and supplier payments as they fall due.

As a line of credit that grows in tandem with turnover, debtor finance is an ideal solution for businesses experiencing strong growth.  A typical facility will advance 80% of the value of the receivables, so $400,000 would be available against a ledger of $500,000; $800,000 would be available against a ledger of $1,000,000 and so on.

At Scottish Pacific our facilities also come with the option of additional services such as risk assessments on potential new customers, collections, including follow up calls, reminder letters and statements. These facilities provide more than just a line of credit, they encompass an outsourced solution that small business owners, in particular, value very highly as it allows them to concentrate on growing their businesses without having to perform these functions themselves and incur the extra cost of recruiting additional staff.

Used wisely, a debtor finance facility can add significant value. With more cash available, stock can be purchased in larger quantities and paid for more quickly in exchange for discounts thus improving gross margin. Used in this way, debtor finance can actually pay for itself.

To summarise:

  • The funding available through a debtor finance facility grows in line with sales
  • Businesses are able to access the extra cash required to fulfil an increasing order book
  • Real estate security is generally not required
  • Additional complimentary ledger management services are available
  • Used wisely, facilities may pay for themselves
  • Facilities can provide a valuable alternate source of finance in turnaround and start up situations.

So what are the alternatives ?

By far the most common is an overdraft facility secured by real estate security. In headline terms this alternative is likely to be the cheapest and will work well provided the working capital requirement does not exceed the value of the real estate security. In the boom times and pre the Global Financial Crisis, it was possible that security values might increase in line with sales even in a high growth business, but the landscape has changed dramatically since 2007.

What comes into question then is the opportunity cost to a business that has to turn away orders because it is bumping up against the overdraft limit and how is its relationship with its bank being affected. The business is growing and there’s nothing wrong with it other than the credit available is insufficient for the size it has grown to, but the bank may not see it that way.

So in summary, factors to consider when looking at an overdraft facility are:  

  • The secured overdraft, in headline terms, is likely to be the cheaper option
  • Real estate security is required
  • The facility size is limited by the value of the real estate
  • The credit available is not linked to the performance of the business

Other alternatives such as unsecured overdraft facilities, raising private equity or offering early settlement discounts all typically work out more expensive than debtor finance, without the option of the additional services. Ultimately the key is to find the right fit for the business, so that the finance arrangements not only support the current needs of the business, but will also enable it to grow without undue constraint. Debtor finance is one of the few forms of finance with that level of flexibility and should always be considered as a viable alternative for businesses looking to optimise their working capital facility requirements.