In this article, Paul Below, provider of Board level interim and turnaround support, outlines some of the pitfalls of debtor finance.

With many years of providing support, Paul has been involved in a number of cases where invoice finance has been a really useful and well operated source of funding. But has also been asked to help in cases where it has gone wrong.

When it goes fishy …

“Examples I have seen include one case where the ledgers got in such a mess (both company and funder !) that the errors were on the scale of the company’s turnover ! In another, a high value invoice was raised where the goods had not been shipped but were in debtors once and counted twice in stock  (and had not even been made !)

“These are some of the more extreme situations but hopefully the following tips may help steer you away from some of the lesser pitfalls.

The Lobster Pot

“Financing a business with debtor finance is a little like climbing into a lobster pot. It is easy to get into and liberate that extra cash. But climbing out again by repaying a level of debt, which likely represents many years’ profit, may not be quite so easy.

“It is key therefore to ensuring that this method of financing is right for your business and that you are comfortable with entering what will be a long term  relationship with your lender. Take advice. Take references.

Keep Swimming

“This form of finance is best suited to steady growing businesses. As the business grows, so does the working capital funding – it’s a virtuous circle.

“A shark has to keep swimming to stay alive. Keep swimming (making sales) and everything is fine. But stop and you will soon be struggling to breathe (no sales = no cash)

“So, understand the implications if you have a seasonal business eg one geared to the Christmas season. Sales and cash will flow in up to December. But there could potentially be a hangover in the New Year : your peak levels of supplier bills will be falling due whilst at the same time your cash inflow will be weak. (Remember you have already taken the benefit of your sales – the cash coming in from customers goes to your lender.)

“The same can happen if there is a downturn in business eg following loss of a significant customer or from cyclical fluctuations in your market.

Back to the Relationship

“Have you kept enough cash/facility in reserve for these eventualities ? If not, what is your fallback ? And how strong is your relationship with your funder ? If the requirement is temporary and you have established trust they may be able to offer some temporary assistance such as an “overpayment” to get through a short term issue. But if it is poor they are more likely to reduce the facility, making life even more difficult.

Devil in the Detail

“Another key issue from this form of finance is the administration required  to manage cash, the facility and the business forecasts and budgets. It is not rocket science but it is time consuming, it needs to be done properly and it needs to be understood.  Make sure the monthly recording and reconciliations are timely and accurate.

Cash, cash, cash

“Cash and business forecasts and budgets need to incorporate the funding. Keep your finance team on guard by asking – what is the outlook for changes in disallowables, ? Are you close to any concentration levels ? Are annual rebates significant ? Do these raise any cashflow issues ?

Ignorance of the law …

“Is no excuse. Understand how the policy operates at month end. Funders may well be prepared to let you hold the ledgers open for an extra day at month end to let you finish month end invoicing. But start taking a week or invoicing for goods which have not left the warehouse and you may find your relationship weakening fast – not to mention the exposure under your personal guarantee against fraud !

In summary

“Keep your paperwork and your relationships in good order and it should be plain sailing.

Paul Below provides Board level interim and turnaround support and can be contacted on paulbelow@blueyonder.co.uk