Debtor Financing Advantages and Disadvantages
Debtor financing (also known as Invoice Discounting or Cash Flow finance) involves the practice where you as a business sell your invoices to someone else (usually at a discounted price).
This practice allows you to circumvent the time you would normally have to wait to get your money via invoice payment.
The method of debtor financing has become increasingly popular with small-to-medium enterprises (SMEs) since it allows these companies to get quick access to their capital.
This can be very important since it provides certain flexibility to a company – you can speed up any processes that would otherwise be impossible to get done.
And even though this service sounds like it’s perfect and without any downsides to it, there are a couple of disadvantages (as well as advantages) that you should keep in mind before you actually decide to opt for it.
Improved Cash Flow
We’ve already indicated that debtor financing can improve your company’s cash flow.
This is a clear advantage of the invoice discounting service, as it allows you to (re)distribute your money and to use it for other purposes.
If you’ve ever managed the company’s finances you know just how important it is to have this possibility to use the cash to operate some day-to-day activities, thus providing the company to grow further.
Reduced Profit
The first clear disadvantage of debtor financing is the fact that it inevitably reduces your overall profit.
Although it shouldn’t come as a surprise that the factor always charges a percentage, which is somewhere between 1-3% of the overall invoice value, you still have to crunch your numbers and see if this is a good deal for you or not, in each situation.
Sometimes it happens that this percentage is not actually the deciding factor and not that big of a thing, especially if you need money ASAP, or the contract is not that big.
But for bigger contracts it’s advisable to double-check if the numbers are alright – you’ll be paying a significant sum to the factor if you don’t put this into the equation.
You Can Save Both Time and Resources
To go back to some of the advantages of debtor financing: even though you’ll lose part of the profit, you’ll still save both time and resources by the sheer fact that your cash flow is improved.
Since it’s highly likely that you’d spend too much time managing and chasing invoices, the reduced profit that you’re looking at doesn’t necessarily mean that you’re losing money.
This is especially the case if you choose a reliable option like Classic Funding Group – that way you’ll be able to get even more efficient. So, once again, you have to calculate the pros and cons.
If you use the resources that you acquire wisely and take advantage of the cash flow the proper way, you’ll most definitely minimize the losses.
Debtor Financing Isn’t Always the Best Option
It’s no secret that every business plan has its upsides and downsides, and debtor financing is not an exception to this rule.
Arguably the most limiting factor of debtor financing is that you can use it to solve only one specific problem.
It’s awesome that you can distribute the cash for other purposes, but there’s actually a limitation to this.
For instance, if you’re thinking about expanding your company and you want to buy new equipment, debtor financing won’t be of too much help here.
Another reason why debtor financing can be a problem for some companies is that it puts them in temporary debt.
This short-term debt can happen when a customer disputes the invoice or ends up paying late (or not paying at all, which is the worst-case scenario).
Luckily, this short-term debt is paid off as soon as the customer pays the invoice.
Invoices Discounting Leads to a Faster Growth of Your Company
Even though you can’t use the cash that you get via debtor financing for everything you might want, it’s still a great option to consider in case you’re looking to expand and provide your company with faster growth overall.
You may not be able to buy new equipment, but you can nevertheless spend the money on other things that will put you in a position to further expand your business.
Every company leader or manager knows that a healthy business needs a decent level of finance to operate the right way.
Invoices discounting provides you exactly this – you’ll be able to further invest your money and close more deals consequently.
When this type of business model is implemented the right way, you’ll get a chance to maximize the profit.
Consider debtor financing as a good investment plan – you can definitely get a good ROI (return on investment) on the reduced profit that invoices discounting includes.
The Bottom Line
Like any business plan, debtor financing has its pros and cons. In this article, we’ve tried to present to you some of the advantages and disadvantages of debtor financing.
Things like reduced profit, limited cash distribution, and temporary debt are reasons why this model is not exactly the picture-perfect.
But even though there are these disadvantages and certain cons to this financing solution, we should also keep in mind some of the benefits of this model.
These would have to include improved cash flow, the possibility to save both time and resources, and the fact that invoices discounting can lead to faster growth of your company.
Before you decide to take further action, we strongly advise you to crunch the numbers and seek professional help if you have any troubles or doubts along the way.
Category: Business
