Debt is one of those things that no one likes but is a necessary evil in today’s global market. No one wants to be in debt but a loan is an excellent way of getting things going. Rarely do we have enough finances to get started with a business endeavor.
A not so well known term for the majority of businesses is debtor finance. It is something any enterprise can benefit from, provided it works with credit terms and invoices.
The basic concept of debtor finance is when an account receivable is used to secure a line of credit. What this does is it gives the user an opportunity to improve cash flow and finance the business by relying on internal income as opposed to getting into more debt.
What you owe to your creditors is what you are owed by your own debtors. Let’s list some of the ways that debtor finance can be beneficial for small businesses.
Table of Contents
1. Cash flow
The main problem, especially for businesses that are just starting, is their initial cash flow. Even if the company is actually turning a profit, their books seem to indicate insufficient funds to cover operational expenses.
The reason for this paradox is that most of the profit accrued is in the form of account receivables. It basically puts a time barrier between gathering that money by selling goods and services and actually collecting it.
At certain points in a business process, you will have money on paper, but in reality, you are suffering from a lack of finances. This is an issue. The reason for that is that there are no free delays in paying the financial obligations that you need to settle every month or every fiscal year.
Expenses cannot wait, employees and suppliers expect to get paid in time. They all have their own deadlines and you cannot function without them. Thankfully, the debtor finance model will give you a sort of buffer when dealing with these kinds of problems.
2. Working capital
Another very important indicator of a company’s overall wellbeing is its working capital. We have all been in a situation when debtors are not paying what they owe, at least not in time.
Ultimately, it is you that comes up short and it hurts your business by not being able to pay your bills and other obligations. Not to mention such practice hinders your ability to grow your business.
Debtor finance is very important for companies that are struggling with their working capital. It can be used to free up cash and provides you with more options to take action to grow your business.
Buying power is the name of the game, the more you have it, the better your options are. The trick is to disassociate working capital from invoices.
Businesses have a much better time operating and expanding when they get paid immediately. This is often not the case and that is where debtor financing comes in and saves the day.
3. Sub-optimal alternatives
The major advantage of debtor financing is that it aids in acquiring funds without the need for selling invoices. Yes, invoices can be sold for a quick capital injection but in the bigger picture, you are relinquishing a substantial portion of your income in favor of an immediate influx of cash.
When talking about numbers, about 85% of the money you will receive right away. Then, you pay a fee that is most commonly anywhere between 1.5 to 5 percent of the total sum involved.
Lastly, you have to wait for the rest of the money to come in, which is about 10 to 13,5 percent of the invoice value. With debtor financing, you are bypassing this entire ordeal.
4. The line of credit
Debtor financing is a line of credit type of loan. What this means is that businesses use this method anytime a need for additional funds arise and it doesn’t make any sense to apply for a bigger loan. Preemptively getting a loan from a bank entails a lot of obligations and is less efficient, overall.
You should commit to this only if there is no other option. This is the main reason most businesses go for a line of credit as opposed to a traditional bank loan.
5. The more favorable course of action
Debtor finance is a business-friendly option to go for, overall. It is flexible to suit your needs and it can scale appropriately as your business grows. When your profits and capital grows, so should your credit fund as well.
That is because you can borrow as much money as you are being owed. It allows you to retain company equity along with improving your cash flow, which we have mentioned earlier in this article.
Ultimately, it provides you with more options and therefore, negotiating power as you will never be starved of finances to support your business endeavors.
Debtor financing and its various options are just some of the tools that you can use to maintain and expand your business. It is by no means the only one and should be used in conjunction with other methods. Make sure that you are eligible for debtor finance and add another very powerful tool to your roster.
Alex is fascinated with “understanding” people. It’s actually what drives everything he does. He believes in a thoughtful exploration of how you shape your thoughts, experience of the world.