With a growing number of Australian manufacturing companies seeking alternative ways to fund operations, Lee Clarke looks at debtor finance and how it can be used to support business growth.
Manufacturing accounts for approximately 20% of the $60 billion in total debtor finance annual turnover.
Many manufacturers lament the fact that they are profitable on paper but continue to suffer from poor cash flow positions. While many companies face cash flow constraints from time-to-time (regardless of the industry in which they operate), the problem is particularly acute in the manufacturing sector.
The key cause of ongoing cash flow issues for the manufacturing industry rests with the inevitable ‘cost/payment lag’ – the time between when the costs associated with manufacturing a product are incurred and when payment from customers is received.
The net result of this ‘cost/payment lag’ is a large proportion of a manufacturer’s working capital being tied up in materials, stock and debtors, often leaving an inadequate sum of working capital to pursue growth opportunities.
The continuing trend of businesses taking longer to pay their bills only makes effective cash flow management more difficult, particularly so given the largest businesses often take the longest to pay.
The extent to which debtor finance is able to provide a workable funding solution for manufacturers can be seen in the latest DIFA statistics, which reveal that the sector accounts for approximately 20% of the $60 billion in total debtor finance annual turnover.
How debtor finance works
In the past there has been an element of confusion surrounding what debtor finance is and how it works. This confusion stems partly from the fact that debtor finance goes by a number of names, including receivables finance, invoice financing, cash-flow finance, and the list goes on. All these terms are correct.
Regardless of the name ascribed, debtor finance is a simple and straightforward finance facility, working in either of the following ways:
Factoring and discounting are two options for businesses to improve their cash flow. Both of these financial arrangements are primarily secured against the unpaid invoices of a business.
Under both facilities the client sells the unpaid invoices for immediate access to cash, but under the factoring arrangement the debtor finance provider additionally manages the client’s sales ledger and collection of accounts. Therefore, under a factoring arrangement the debtor makes payments directly to the provider.
Under discounting, the debtor makes payments to the company, as per usual, but as the debt is owned by the provider, the company manages the collection process and then passes the revenue collected to the provider.
Generally, a discounting arrangement would be utilised by larger organisations as they have the in-house resources in place to manage collections and the sales ledger. Conversely, smaller organisations often prefer a factoring arrangement as they are alleviated of the responsibility of managing collections, allowing the firm’s personnel to concentrate on other business functions.
One of the attractions of both discounting and factoring arrangements is that they are self-liquidating facilities, meaning that the company isn’t taking on additional debt per se, but rather taking an advance on money that is already owed to it. The good or service has already been provided, and while the facility needs to be repaid, this should take care of itself as a matter of course as the company’s debtors settle their invoices.
The benefits of debtor finance
While it’s true that debtor finance is at times viewed as a tool to merely overcome short-term cash-flow constraints, there are a growing number of Australian businesses engaging it more strategically to grow their business.
The enhanced cash flow position of a company can be used to employ more staff, for capital expenditure (plant and equipment), or to take advantage of acquisition opportunities.
According to research undertaken by the DIFA, Australian businesses recognised the three key benefits of debtor finance to be;
The freeing of cash within 48 hours (usually varying between 75-90% of the value of an invoice), allowing the business to accelerate growth;
The ability to utilise the improved cash flow position to obtain early settlement discounts from suppliers/creditors (up to 5%);
A reduction in management time spent on chasing slow payers (through a factoring arrangement), allowing managers of the business to concentrate on areas more appropriate to their responsibilities, such as driving new business.
The fact that debtor finance generally doesn’t require real estate security is another particularly attractive feature.
Lee Clarke is Chairman of the Debtor and Invoice Finance Association (DIFA), which represents the interests of the major providers of debtor finance in Australia and New Zealand.
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