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How does Debtor Finance work and what are the costs?

Debtor finance

One of the most stressful aspects of running a contracting business is ensuring your working capital requirements are adequate and your cash-flow is under control.

This can be a consequence of having to make payments to contractors on a weekly basis but having your debtors on 30 plus day terms. As contracting businesses grow, it is common for owners to take out debtor finance in order to manage their weekly working capital requirements. Generally, it involves the provision of finance from a banking institution that is secured by the debtor book.

How it works

  1. Invoices that have been sent to debtors are also sent to the bank;

  2. Subject to certain restrictions, the bank will immediately make funds available equating to a defined percentage of the value of the approved invoices. Generally, this can be 75% to 85% of the value of the invoice;

  3. The debtor will then make payment of the invoice to a dedicated bank account in the recruitment agency’s name. At that time, the remaining percentage (ie 15% to 25%) of the invoice value will be paid by the bank to the recruitment agency.

Certain facilities restrict what invoices will be accepted for finance. This may include limiting the finance available for invoices relating to permanent placements or specific debtors.

What are the costs?

Interest and fees

When determining the actual cost of the facility you will need to consider both the interest cost and all associated fees. This will provide you with an effective rate.

Depending on your finance provider, the way they charge will vary. The two most common methods are:

  1. fixed rate based on a minimum amount of expected debtors; or,

  2. fees split into the following:

  3. Invoice acceptance fee – this is a fee payable once invoices are uploaded to the bank. Essentially it is a fee for making the finance available.

  4. Interest rate – this is payable based on the how much is drawn down from the facility.

Currently, effective rates can vary from approximately 6% to over 10%. When comparing finance providers owners must ensure they are comparing apples and apples. It is the effective rate that owners need to compare. This includes all associated fees.

Internal time costs

In addition to the above cost, most institutions will require some form of reconciliation to be provided. The frequency and quantum of this reporting must be factored in when choosing a finance provider. This can vary from weekly to monthly. The owner must ensure it is not too cumbersome an exercise and can be managed by your existing internal accounting team or office manager.

In addition, most finance providers have their own internal audit requirements for their debtor finance clients. These can be either quarterly, half-yearly or annually depending on the agreement with your finance provider. The auditors will review your accounts, invoices, debtors and general working capital.

If you need further information or assistance with the debtor process, please contact Sovereign Private.

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