Debtor finance: What you need to know

If you want a very flexible form of funding for your business, debtor finance can be a great place to start. Start-ups or businesses that are financially recovering from specific issues like bad debt or poor cash flow can turn to debtor financing to support their operations and growth.

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Page written by Ian Hawkins. Last reviewed on October 17, 2024. Next review due July 1, 2025.

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What is debtor finance?

Debtor financing is a financing agreement in which the business can borrow or generate cash using their overdue invoices. Businesses need to maintain a good cash flow to purchase inventory, pay bills, pay wages, and meet other operational needs. However, not all customers pay on time, and that can limit a business’ ability to mobilize its production. To survive and grow, businesses can resort to convenient funding options like debtor finance.

How does debtor finance work?

Lenders and brokers offer debtor financing services. You can receive cash advances based on your issued invoices. You can generate funding without going through a long process and complicated paperwork.

There are various solutions that fall under the category of debtor finance including cash flow finance, asset finance, invoice discounting, and invoice factoring.

How does debt factoring work?

Debt factoring, also called accounts receivables factoring, is when you sell your invoices to a factoring company at a discount. With this option, you can receive a percentage of the outstanding receivables upfront, and the factoring company will be the one to collect payments from your customers. When the factoring company collects all the receivables you’ll receive the rest of the funds minus the factoring company’s fees. This is a great option if you need to bring in cash immediately without waiting for clients to settle their bills.

How does invoice discounting work?

While debt factoring involves selling your invoices, invoice discounting is just a form of short-term borrowing, using your invoices as collateral. You can borrow up to 95% of the outstanding invoices. You’ll still be the one to collect the payments and just repay the lender once the invoices are paid, unlike invoice factoring which controls the collection process.

Recourse or non-recourse debtor finance

With recourse loans, if the individual defaults on the responsibility, the lender can go after other assets and financial accounts he/she owns. Non-recourse loans, on the other hand, are generally more favorable to the borrower since the lender can only take the assets used as collateral and nothing else.

Confidential or disclosed funding arrangements

In a disclosed funding arrangement, your customers will know that you are using a financing service while in confidential financing, the agreement will remain undisclosed. Confidential arrangements allow you to remain in control of your customer relationships, but this usually comes with higher fees and interest rates and lower credit limits. Also, it has stricter credit assessment requirements, and only established firms usually meet the criteria. However, you shouldn’t worry about using disclosed funding arrangements because disclosed financing is becoming widely accepted in the trading industry, and it’s no longer something that’s looked down upon. If anything, it shows that your company is powering ahead.

What are the different types of debtor finance?

Debtor finance includes various forms of financing where a business uses its accounts receivable as collateral to get funding. The main types include factoring, invoice discounting, and asset-based lending.

Factoring: A business sells its accounts receivable to a factoring company at a discount. The factoring company then collects the debts from the business’s customers.
Invoice discounting: Unlike factoring, the business retains control over its sales and collects debts directly from customers. The business borrows money against the value of its unpaid invoices, using them as collateral.
Asset-based lending: This involves borrowing against a broader range of assets, including accounts receivable, inventory, and sometimes equipment or property. ABL provides a revolving line of credit based on the value of these assets.

Each type of debtor finance offers distinct advantages and considerations, depending on the specific needs and circumstances of the business.

Which type of debtor finance is right for my business?

Debtor financing is the catch-all term for all kinds of financing that secure a line of credit using accounts receivables. Whichever type of debtor financing option you go for, it’s generally more flexible than overdrafts or regular bank loans.

When choosing the type of debtor financing option, if you want less work in terms of payment collection, you can choose invoice factoring. However, you’ll get less money for outstanding invoices– usually only 80-90% of the value. With invoice discounting, you get the full value of the overdue invoices, but you need to pay interest on the loan and you still are responsible for collecting payments. If you already have a solid collections department in place, you can just opt for invoice discounting. Whichever you prefer, both are great options to improve your business cash flow and operations.

Who can benefit from debtor finance?

Both SMEs and established companies with a lot of working capital tied up in accounts receivables can benefit from debtor finance. Many types of financing require real estate security or a long business trading history, but debtor finance is very accessible and easy to qualify for.

If new projects or opportunities present themselves yet you don’t have enough capital to support growth, you can easily turn to debtor finance. Or perhaps your collections department requires an overhaul, and there are a lot of delinquent accounts. To minimize stress, you can work with an invoice factoring company to take care of all the collection efforts.

If your business loan is not enough or your business loan applications keep on getting rejected, try debtor financing as it has a higher approval rate. Easily free up all the working capital tied up in your unpaid invoices. Make the most of debtor finance to sustain or supercharge your business.

What are the benefits of debtor finance?

Debtor finance offers several advantages for businesses. Firstly, it provides an immediate injection of cash flow by unlocking the value tied up in accounts receivable. This can help businesses meet immediate financial obligations, such as paying suppliers or covering operating expenses, without waiting for customers to pay their invoices.

Secondly, debtor finance can improve liquidity and working capital management. By converting accounts receivable into cash, businesses can better manage their cash flow and have funds available for growth opportunities or unexpected expenses.

Additionally, debtor finance can help businesses reduce the risk of bad debt or late payments. By outsourcing credit management and collection activities to a third-party finance provider, businesses can reduce the administrative burden and financial risk related to chasing unpaid invoices.

Furthermore, debtor finance can be a flexible financing solution that grows with the business. As sales increase and accounts receivable grow, businesses can access more funding through debtor finance without the need for additional collateral or credit checks.

Is debtor finance right for my business?

Debtor finance is no longer just a matter of alleviating unexpected cash flow challenges but is increasingly being used as a tool for strategic growth. From startups to established enterprises, debtor finance is an adaptable and robust solution for unique business challenges.

SMEs with a turnover of at least $200,000 are best suited for debtor finances. Especially for those edging closer to the $1 million turnover mark, they need to look at debtor finance not just as a means to survive but as a chance to unlock more growth opportunities. Go beyond survival and aim for strategic growth by expanding revenue streams, facilitating mergers and acquisitions, or securing raw materials at more competitive prices. Overall, debtor finance can support both your short-term and long-term goals.

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Written by

Ian Hawkins

Ian Hawkins is Head of Content at Swoop. As a freelance business journalist and filmmaker he has reported from Europe, Central and North America and Africa. His films and writing have appeared on BBC World, Reuters and CBS, and he has spoken at conferences on both sides of the Atlantic on subjects including data, cyber security, and entrepreneurialism.

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