Business Bookkeepping & IT Solutions

Best Working Capital Options

Cash flow is the lifeblood of any business, yet sourcing adequate working capital can be a challenge for many, even businesses that are profitable and have a strong growth trajectory.

The concerns raised in the late 2016 House of Representatives Standing Committee on Economics report into the banking sector suggest that the banks are not making it easy to find business funding.

This highlights the need for SMEs and their advisers to look beyond the banks for funding.

This is a key area where accountants can provide insight and support to their clients. Scottish Pacific’s SME Growth Index, which surveyed more than 1,200 business owners, found that accountants sit in the top three most trusted business advisers. The other two were trading partners and friends.

Most accountants will be aware that, in many cases, non-bank alternatives to the traditional overdraft are better suited to the needs of a fast-growing business.

How can SMEs gain easier access to the funds they require to grow?

One option for trading businesses is debtor finance, which has come a long way since the 70s and early 80s when it was considered by many in the accounting profession to be a last resort and only relevant to struggling businesses.

It is now a much better understood funding option for SMEs in all major western economies, with take-up accelerating significantly in Australia over the past 15 years. Many of Australia’s largest companies are paying suppliers who use debtor finance to handle fast growth and working capital issues.

More than 4,000 Australian SMEs, with combined annual revenues in excess of $60 billion, now use debtor finance.

Scottish Pacific funds businesses with annual sales revenues ranging from start-up to $500 million. Other providers include most of the banks, except ANZ and CBA, and small regional independents. Globally, it is the large specialist debtor financiers who tend to have the widest range of options, enabling them to tailor solutions to a business’ specific circumstances.

How does debtor finance work?

Debtor finance is a revolving line of credit secured by outstanding sales invoices, typically giving businesses access to 80 per cent of the value of outstanding receivables at any given time.

There is no requirement for real estate security, which frees up the family home to support personal investment plans and makes for easier succession planning.

Because the amount of working capital available is linked to the receivables ledger, the credit available grows in line with business revenues, enabling entrepreneurs to focus on running their business without having to worry about breaching limits or re-negotiating terms with the bank.

Used wisely, debtor finance facilities will pay for themselves in a short period of time either by enabling a business to take advantage of profitable growth opportunities that would otherwise have to be turned down due to an inability to fund them or by negotiating discounts from suppliers in return for buying in greater quantities or offering earlier payment.

Understanding when debtor finance is a solution for clients

SMEs most likely to fit the debtor finance client profile are growth businesses offering products or services to other businesses or government bodies, on standard trade credit terms – in particular, SMEs supplying temporary labour hire, transport and road haulage, manufacturing, wholesale trade, distribution and printing.

Here are a few of the main situations to look out for, to help start a funding conversation with SME clients:

Growing businesses

Growing businesses are cash-hungry. If a profitable business is turning orders away because there is no cash to fund the growth, debtor finance is an ideal solution. The facility will pay for itself very quickly, supporting the business’ current needs and growth plans with a facility that automatically grows with them.

Debtor finance is one of the few forms of finance with this flexibility. In comparison with a bank overdraft, you don’t have to be constantly increasing limits as the business expands.

As a line of credit that grows in tandem with turnover, debtor finance is an ideal solution for strong growth businesses keen to free themselves from often restrictive bank covenants.

Management buyouts/mergers and acquisitions

There are many examples of debtor finance funding MBO and M&A activity. Putting a facility in place means that the target business’ receivables ledger can be utilised to generate funds to help in the purchase or to provide ongoing working capital.

Entrepreneurs and start-ups

Many new businesses fall foul of the standard bank criteria of two years’ trading history. Faced with rejection, start-ups might wrongly think their only funding option is to re-mortgage or hit up family and friends for a loan.

Debtor finance offers new businesses access to working capital that would otherwise be tied up in receivables for 30 or more days.

It can help grow the business by providing the funding required to employ new staff, purchase stock or support capital expenditure.

One advantage for an early-stage business is that it is a self-liquidating facility. Instead of taking on additional debt, the business receives an advance on money it is already owed.

Unlike overdrafts, debtor finance does not generally require real estate security. It is a standalone facility that can sit alongside other business borrowings such as term loans and leasing.

Turnaround and divorce

Debtor finance can be used to support businesses in turnaround situations, if there is a strong underlying business that has a short-term cash flow problem (perhaps caused by an issue such as a bad debt, loss of a major customer, productivity delay or seasonal issues).

A business that is in turnaround but has a sound plan can generate an immediate cash injection from the receivables ledger to provide the breathing space that allows underlying issues to be resolved.

Debtor finance also works in a different type of distress situation – divorce. When a relationship comes to an end, it is common for one partner to take the family home and the other to take the business.

The downside in this scenario is that the house can no longer be used to fund the business. Debtor finance can take the house out of the equation in providing capital for the business.

Valued advisers

Over the years, we’ve been able to use many real examples to alleviate any initial concerns accountants might have about recommending this funding solution to their clients.

One concern I mentioned earlier is the “last resort” myth. Many clients have been using debtor finance for more than a decade and some for more than 20 years. These are well-established, successful businesses.

Another concern we hear from accountants who have not experienced debtor finance is that it is an expensive option. Over time, the costs have come down significantly and are now comparable with bank unsecured lending rates.

When helping potential clients to compare the costs associated with other funding options, we make sure they understand the opportunity cost of turning orders away. It is also important to factor in the lower level of security required, faster approval times and the flexibility of an overall funding limit that will grow in line with turnover, with no requirement for annual reviews or restrictive covenants typically associated with traditional business overdrafts.

We’ve also helped accountants who were sceptics to see debtor finance in a different light and become advocates over time.

Peter Morgan, a qualified accountant and business manager at Innovatus Group, is a great example of a sceptic-turned-convert.

“To accountants who might be under misconceptions about debtor finance, in reality, debtor finance is not a last resort option for troubled businesses. It’s a good strategic option for any advisory firm to have in their broad suite of products,” Mr Morgan said.

If you have clients who are experiencing rapid growth, just starting out or looking to transition via succession, MBO or M&A, think about the advantages of using a business asset and not risking the family home to secure funding.

It could be time to take a closer look at what debtor finance can offer.

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