Explain what Debitor Finance

Explain what Debitor Finance

The average commercial payment deadlines are currently around 60 days a statistic that has been steadily increasing in recent years. A business deal on credit terms with other companies will over time accumulate a significant asset in its balance sheet known as accounts receivable or accounts receivable.

Debtor Finance is a broad description describing a type of economy that uses trade receivables as collateral for a cash advance. In technical terms there are a number of legal models for debt financing. In some situations it is simply structured as a loan with collateral assets that function as collateral as a home loan.

On the other hand factoring usually involves legal ownership of debts transferred to the financier possibly indefinitely ie the debtor is not informed - or more often fully informed if the debtor has been aware of the financing arrangement.

When debtor financing is in the form of a debt factor agreement the available cash advances can be adjusted flexibly according to a percentage of debtor sales providing a high level of convenience for a company that expands and needs more money to do so.

Security requirements for Debtor Finance

All debtor financing systems have certain security requirements firstly directly over the claims but also possibly (less desirable from the borrowers point of view) supported by collateral or personal guarantees.

As with other forms of credit linked to the value of the underlying collateral the borrowed or funded amount depends on asset values. Normally debt financing financing is allowed for about 70% to 90% of the debtor invoices value.

Advances and cash flows

A factor arrangement involving the financing of the entire debtors ledger can effectively function just like an overdraft. This means that the borrower can effectively draw and repay amounts at any time within the limits of the total funding limits and taking account of such factors as bad debts when they arise.

Smaller financing arrangements that include Invoice Financing or Invoice Settlements will generally split up into two cash flow sums:

The first lump is the advance for 70% to 90% of the invoice value

The second lump is the balance from which financiers recover taxes.

Each method of financing has its advantages and disadvantages. Financing of the entire debtors ledger will usually imply certain contractual obligations for a period of at least 6 months often a year or more. Invoicing on the other hand is generally shorter and can not require a fixed maturity. Invoicing is very flexible when used on an ad hoc basis which helps keep costs down but it is usually necessary to monitor actual cash flows.

When does the borrower charge the best option?

Debtor financing is most useful for a company that has a relatively long cash conversion time compared with the cost of its major deliveries. This is best explained as an example: Simplistic if a company has to pay all its bills on an average of for example 21 days but the termination terms for most of its customers are 45 days or more expanding business will always absorb more money than which is available from the business in the short term.

This type of cash flow tension occurs most often in manufacturing companies wholesalers and employment companies. In practice all transactions where the selling cost consists largely of labor costs or stocks.

If other sources of funding are not available or are more expensive when they enter the companys balance sheet for a debt financing scheme they may release cash for the next project or job while valued customers may still use their normal payment terms.

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