What is Debtor Finance and how does it work?

March 5th, 2020

Everything you need to know about debtor finance and how it could benefit your business.

Typically, the tightest month of the year for Aussie businesses is February. With Xero Small Business Insights reporting just 47% of Australian small businesses having positive cash flow, on average, over the past five years. February is a tough month for businesses, as invoices tend to be paid later than in other months. It’s also a time when to fork out for stock top ups post Christmas period. All factors which can contribute to a negative working capital. 

Sadly, Xero predicts further slumps for this year’s March and April reports (though figures are yet to be released) as a result of the COVID-19 pandemic. And it’ll come as no surprise to most that this period is expected to be the toughest some small businesses may have faced in their lifetimes. Therefore, it’s more important than ever that businesses get paid on time.

Debtor finance (also known as invoice finance and accounts receivable finance) is well suited to these tight cash flow periods where invoices are paid later than expected. This is because it allows business owners to access cash that’s locked up in customer invoices, ahead of client payment.

What is debtor finance?

Debtor finance is a type of short-term business loan that lets business owners draw funds against unpaid invoices. These arrangements are repaid when the invoice is paid by the customer. Bringing forward this cash flow can be useful for covering operating expenses and maintaining ongoing positive working capital when cash flow is tight. 

With debtor finance, a business can typically draw up to 80% of their accounts receivable ledger ahead of payment. And because the ledger is the main security for the loan, business owners don’t need to use real estate as security.

How does it work?

Debtor financing works by forwarding your chosen issued (but as of yet unpaid) invoice to a provider. Once the provider has verified the invoice, they will lend you a percentage - usually 80% - upfront. 

Since customer invoices are security for debtor finance facilities, the lender will require an accurate and up-to-date view of the accounts receivable ledger. Some traditional lenders still require borrowers to upload invoices and accounts receivable ledgers which adds an administrative and bookkeeping burden for businesses.


The benefits of modern debtor finance

Modern debtor finance providers like Earlypay integrate with Xero and MYOB. This means that invoices can be viewed automatically and in real-time, which saves time for business owners and their teams. This connected integration means both lender and borrower are clear on the amount available for finance and invoice and loan repayment are automatically reconciled. 

Cloud accounting software platforms also solve a big pain point of traditional debtor finance - reconciling invoice payments to invoices. Earlypay and other modern providers can automatically post journal entries to your accounting software. This allows bookkeepers to reconcile invoice payments and loan repayments to bank transactions, with a click of a button.

Different types of debtor finance

Within invoice factoring and invoice discounting, there are a further two groups of debtor finance based on which invoices are used to access funds.

1. Full ledger. This is where the entire accounts receivable ledger is used to access finance. This maximises the amount of debtor finance that can be accessed as all of the accounts receivable can be drawn against.

2. Partial ledger. This is where you draw funds against less than all of the accounts receivables ledger. This can range from single invoice finance, where only one invoice is financed from the whole ledger, to all of the ledger except for one customer.

Often, debtor finance facilities operate as a line of credit and the available limit increases as invoices are raised and reduces when they are paid. 

Further benefits of debtor finance

As well as accelerating cash flow from invoices, debtor finance also provides certainty around timing, as invoice payments are often difficult to predict, and take longer than they should. Because debtor finance is repaid immediately when the customer invoices are paid, there are usually no ongoing fees and charges for using a debtor financing provider.

It can also be a good way to access business finance while borrowing within the means of the business, as you never borrow more than you can repay. Many businesses prefer this to traditional business loans, where repayments are taken weekly or monthly with fees and interest payments, regardless of the cash flow situation of the business.

How much debtor finance can I get?

The amount you can borrow using debtor finance is linked to the value of invoices that are eligible for finance. Most lenders consider eligible invoices to be:

  • For goods or services that have been completed
  • Made out to customers with a good credit standing
  • Less than 90 days past the invoice issue date

Am I eligible for debtor finance?

On top of having good quality invoices that are suitable for debtor finance, lenders will also assess the creditworthiness of your business. This will include a review of  revenues, profits, cash flow, existing debt levels and the time you have been in business. In the case of Earlypay, we look for:

  • A valid ACN
  • More than 12 months in business
  • Invoices with other strong Australian businesses
  • Invoices are issued only after goods or services have been delivered
  • At least $1m annual revenue
  • Minimum of three customers
  • Integration with Xero or MYOB

Is debtor finance right for my business?

Whether debtor finance is right for your business will depend on factors such as your business model, its size and circumstances, and what you need the finance for. If you want finance to boost working capital to help your business grow, a debtor finance facility that releases cash from your unpaid invoices could be the answer. However, if you are buying long-term equipment, an equipment loan that's repaid throughout the life of the equipment might be a better option.

With the increasing range of business finance options driven by the rise of fintech lenders, it's always a good idea to check in with your trusted adviser for some advice. They will have some experience in assessing financing options and be able to help you work out the best type of finance for you and your business.

Debtor finance that's easier than ever before

Business lenders that integrate with the popular cloud accounting platforms are making debtor finance easier and more accessible for Australian small businesses than ever before.

If you think that your business can benefit from Earlypay's modern debtor finance facility and would like to find out more, please contact our team today on 1300 760 205.

If you'd like to learn how Earlypay's Invoice Finance & Equipment Finance can help you boost your working capital to fund growth or keep on top of day-to-day operations of your business, contact Earlypay's helpful team today on 1300 760 205, visit our sign-up form or contact [email protected].