Debtor finance: expensive when compared to what?

The availability of working capital is fundamental in terms of business growth, especially for small to medium-sized enterprises. The current world-wide economic slowdown, high interest rates and increasingly stringent loan application procedures being implemented by financial institutions, however, are making it increasingly difficult for business owners to improve their cash flow status. The Debtor Finance Committee of the Banking Association maintains that companies seeking to expand their working capital need to explore more than the traditional overdraft and loan options available to them, rather leveraging their debtors to far better effect…

Current market conditions have made alternative financing options necessary when it comes to increasing working capital, with business owners having to reconsider more ‘traditional’ approaches in terms of both their costs and benefits. Although debtor finance is receiving more attention from companies looking to grow their businesses, many still view the option with some scepticism due to perceived related costs and the risks associated with stagnant debtor book growth.

When providing financial assistance to businesses, financial institutions will more than likely do so in the form of an overdraft facility linked to a particular interest rate. Debt security instruments, such as the bonding of properties, would also need to be put in place. The debtor finance option on the other hand allows the business owner to leverage their debtor book up to 80% of projected income, giving them access to a much larger sum of money. Monies are advanced at prime (or prime plus) interest rates and are coupled with a monthly management fee of approximately R5 000. No further debt security, such as bonds are required.

To put this in perspective, a R5m debtor’s book would probably attract an overdraft facility of around R1m from a financial institution. The same size book, provided the debtor rating was sound, could attract an advance of up to R3m through the debtor financing option. A larger cash injection is thus obtained at no added risk to the business in terms of ceding other assets.

With the interest repayable on both an overdraft facility and on the debtor finance package the same, the additional debtor finance “cost” of R60 000 per annum as a result of the monthly management fee needs to be evaluated in terms of what the extra R2m could facilitate for the company. If the company was to grow only a very conservative 10% during the year, this R2m would generate a profit of R200 000 – a net profit of R140 000 more (after subtracting the annual management fee) than could be earned on the overdraft facility.

Having this additional R2m of finance available would also enable one to take advantage of more early settlement discounts and other similar trade discounts – again increasing overall company profits.

The debtor financing monthly fee also brings with its own set of benefits providing loan applicants with a number of value-added risk control interventions, including a debtor rating service aimed at identifying sound suppliers, internal procedure audits, Financial Advisory and Intermediary Services (FAIS) advisory services and monthly debtor performance reports.

When it comes to evaluating one’s options to expand working capital then, one needs to look at perceived “costs” in relation to the opportunities – and profits – they create. Instead of merely “crunching the numbers”, business owners looking to grow their companies should rather be asking themselves whether they can afford not to investigate debtor finance and leverage their company assets to the maximum.