Small business:

Anthony O’Brien

Waiting for customers to pay an invoice is a major bugbear for small business owners. Slow payments create cash flow challenges and some businesses are now looking beyond traditional bank overdrafts to “invoice finance” (also known as factoring or debtor finance) to cover shortfalls. With factoring, your facility limit is based on your accounts receivable balances – in other words, your outstanding invoices.

By using factoring, it’s possible to avoid the frustrating 30- or 45-day wait – and it’s sometimes longer – for customers to pay their invoices. Moreover, most debtor financing facilities don’t require real estate security such as the family home to enable your business to access finance.

Growth industry

There are more than 4000 Australian SMEs, with combined annual revenues of $65 billion, using debtor finance, according to the latest industry figures.

Banks including NAB and Westpac offer factoring services, as well as the likes of listed entities such as Scottish Pacific Business Finance, which is part of the Scottish Pacific Group (ASX: SCO). Globally, FCI (formerly International Factors Group) data shows the factoring industry registered trading volumes of more than ¤2.35 trillion ($3.5 trillion) in 2016, and for the past 20 years it has grown at over 9%pa.

Wholesalers, manufacturers, property and business services, wholesalers, transport and storage companies, as well as labour hire firms, are among the biggest users of factoring in Australia, according to the factoring industry peak body, the Debtor and Invoice Finance Association.

On the flip side, factoring is not usually used by building contractors, professional services firms and retailers. “Debtor finance, for example, is not suitable for retailers because they sell on cash,” says Peter Langham, CEO of Scottish Pacific Business Finance.

How it works

A business will invoice its client directly, and then upload the invoice to the debtor finance provider. Generally, a factoring company, usually within 24 hours, advances up to 80% of the value of approved invoices, less fees, to the business. The remaining 20% becomes available to the business when the invoice is paid in full.

“Technically the factoring companies own the receivables. But if the invoices aren’t paid, the debt returns to the business that has created them,” says Langham.

To ensure that bad debts are minimised, factoring companies undertake due diligence of all debtors. “We won’t give money out against an invoice if we don’t think the debtor will pay,” says Langham. “We do our checks on every debtor and chase up debts too if required.” This helps protect a small business against bad debts.

However, there’s another benefit too. As a small business owner, I know it can be challenging to combine the roles of salesman and debt collector. For a fee, a factoring service can jump in and take on the bad-guy role of debt collection for your business and let you get on with building a sales relationship with your clients. For its factoring services, Scottish Pacific charges roughly an annual interest rate of 8% against the value of an invoice, and a 1% management fee if additional services such as debt collection are required.

When it’s a good solution

Debtor finance can provide the capital required to fund growth. “We generally look at businesses who have the potential to grow their sales ledger to $50,000 quite quickly,” says Langham. “Below $30,000$40,000 most people are using their credit card to fund their business.”

Factoring can also work well for start-ups as debtor financiers are more concerned with future potential than business plans. “We look at what an SME is doing today. If they aren’t getting the sales, we won’t be funding them,” says Langham.

Factoring can be used for refinancing, particularly as an option to free up real estate property from the security mix. It’s also useful for businesses that are in turnaround mode. These will fundamentally be good businesses recovering from a specific issue that has had an adverse impact on their cash flow, such as a bad debt or a loss of production, says Langham.

Spot factoring

If your company needs income quickly, possibly to cover a one-time payment or meet the monthly payroll, you might consider spot or single factoring. “This is for when you’re looking to access the funds from one invoice or a single load as quickly as possible,” says Bessie Hassan from comparison website Finder.com.au. However, keep in mind that the speed of spot factoring is reflected in the costs, which can be high. “As an application fee and service charge apply, along with rates of as high as 12%, this makes spot factoring an expensive means of bringing in revenue.”