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Product choice critical when financing business

13 October 2008 Banking Association Debtor Finance Committee

Searching for a means to increase your working capital and grow your business? While most companies will typically look to the more traditional financial tools such as an overdraft or bank loan to do this, the Debtor Finance Committee of the Banking Association suggests that business owners and managers explore and understand all the options available to them before making their decision – possibly discovering that debtor finance is the perfectly suited instrument to grow their business.

The bank overdraft is a well known and extremely well utilised financial tool the world over. In spite of proving beneficial to numerous companies however, it is a product often “over-prescribed” to businesses in search of additional working capital. Repayable on demand and governed by a strict limit, its lack of flexibility and stringent requirements (a proven track record of business, tangible security and desirable set of financials) often mean that numerous businesses will not be able to qualify for the product. What many companies fail to realise however, is that there is a more flexible, arguably better geared product available from reputable institutions and financiers to enable working capital: debtor finance.

Considerably less onerous in terms of requirements, debtor finance is already overtaking the overdraft in many developed countries as a means of growing business. Rather than being restricted by a normal overdraft limit, debtor finance is geared to turnover – essentially allowing a business to “sell” its debtors or certain invoices. Because one only really needs a set of well-paying, reputable debtors to qualify, debtor finance is that much more accessible to companies without an extensive track record or a less than desirable balance sheet.

While both an overdraft facility and debtor finance give one access to additional capital, debtor finance does not have the ceiling limit of an overdraft – being determined by the debtors or invoices “sold” to the financier. As such, debtor finance gives one an ongoing means of accessing working capital as opposed to a set amount.

And, when it comes to costs, one needs to weigh up how much the added flexibility of debtor finance is worth. A business making use of an overdraft facility will typically only be required to pay interest on the amount borrowed – with the rate calculated based on the financier’s perceived risks. A company using debtor finance however, may also find itself liable for interest in arrears, or have to pay this upfront based on the number of days the invoice is likely to be outstanding. In addition to the interest charge there is a bookkeeping fee, normally called a factoring fee, which covers the extra management input required indebtor finance.

That being said, these arguably increased costs need to be viewed comparatively in terms of what they enable. Businesses need funds – often more than the set amount prescribed by an overdraft. By having funds on hand, as is typically the case with debtor finance, one gains access to settlement discounts and so forth, which arguably cancel out the factoring fees. And, provided sales continue to be made to good debtors, access to finance can keep pace with working capital needs – making dividend payments possible.

When it comes to choosing the right working capital product for your business then, don’t limit the growth of your business by virtue of your choice. Ensure that your bank or financier puts all available products on the table – so that your decision truly enables your business to grow from strength to strength.

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