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Debtor finance is a type of lending where businesses can borrow money using their accounts receivable as collateral. This allows business owners to use the money owed to them without acquiring additional debt.
Some businesses offer payment terms of 30 days or more when selling goods or services to customers. However, some customers may delay paying their outstanding balance for up to 60 or 90 days or more.
The customer does not make an immediate payment for the purchased goods, but the business has to pay its suppliers along with various expenses like rent, wages, and operating costs. If a business has a large sum of unpaid invoices, it becomes more vulnerable to cash flow issues resulting from a shortage of working capital.
Business owners might decide to opt for a business overdraft or an unsecured loan to tackle cash flow issues. However, these alternatives can come at a high cost and require taking on debt to settle delayed payments from customers.
Another option for businesses is debtor finance, also called invoice financing. This allows them to receive the money they are owed from outstanding accounts receivable immediately. The process involves selling the outstanding invoices to a debtor financing company to access the working capital required.
If a business wants to improve cash flow, they can sell their unpaid invoices to a third-party lender who will provide funds based on the value of those invoices.
The business will send the debtor finance lender the details of the invoice to confirm the amount owed and the date it was issued. Once approved, the lender will then pay a percentage of the invoice amount back to the business within 24 hours.
Usually, when you borrow money through debtor finance, you won’t be charged interest by the lender. Instead, they will pay your business a certain percentage of the amount funded on the invoice. This percentage is called the discount fee.
For instance, the business can receive an advance of 80-95% of invoice values from the lender. Later, the lender will contact the customer to retrieve outstanding payments. The discount fee rate is determined by the value of the business and the debtors being funded..
Compared to an overdraft or an unsecured business loan that comes with interest charges and additional costs, invoice financing can be a more cost-effective option as it does not involve such expenses.
You usually don’t need to offer your family home or business premises as collateral when using invoice financing. Instead, the lender will use your business’s accounts receivable ledger as collateral.
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