Finance and The Economy series: Funding growth minus an overdraft

Debtor – or invoice – finance can eliminate companies’ cash flow crunch.
The facility, whereby third party loans against the invoices companies send to clients, is becoming popular as the perception of it being financing option of last resort subsides. One of the reasons for this change in attitude, says Simon Thompson, CEO of Lock Finance, is that mainstream bank – the BNZ – is now offering this facility.
Unlike an overdraft facility, debtor financing does not require charge on property, plant or machinery. The security is in the ability of your clients to pay their bills.
While some debtor financing firms will pay up to 80 percent of your total ledger, others will choose which invoices they will accept. In this case, an invoice you send to the local council would be fine, but an invoice sent to sole trader without much of track record may be declined.
Debtor financing is different to factoring because your clients need never know third party is involved. It also means that collection is down to you, not the finance company. However, while it can cost more than an overdraft, it can deliver an instant boost to your cash flow.
The BNZ has been offering what it terms invoice financing or invoice discounting since 2003. It is currently the only mainstream bank that does. It’s product that is well-accepted in Europe, the UK and Australia. BNZ’s national manager cash flow solutions, Andrew McKerrow, says that in Australia for example, start-ups aren’t offered overdrafts. “They’re offered invoice financing and through the process the company grows with the bank and the bank gains better understanding of the inner workings of the business. It’s more hands-on collaborative approach.”
McKerrow says the offering is now taking off here; the BNZ achieved 20 percent growth last year and is headed for 20 percent again this year. And, what’s more, over 70 percent of BNZ’s current invoice finance deals are with customers who are new to the bank. “We are targeting any [business] customer that has an overdraft.”
He attributes invoice financing’s relatively late start here to the fact that it is derivation of factoring – which unfortunately still appears to have negative connotation in New Zealand, unlike overseas – and the need to overcome that attitude and educate the business marketplace about the confidentiality and non-disclosure elements that make invoice financing more attractive proposition.
Lock Finance’s Thompson says: “We welcome the banks getting into debtor invoicing because it legitimises [the perception of] it. It is still bit frustrating that there isn’t better awareness and acceptance of it, but it is happening gradually. People need to be educated about it.
“Most New Zealand businesses still opt for [financing] model that includes signing their property away as collateral to bank. Banks tend to put more weighting on property than the balance sheet.
“Debtor financing is perfect for businesses that are in growth mode. BNZ is now in the market and other banks are probably looking at [offering] this type of product as well. It is certainly very active in Australia, and the UK, where there is much more separation between business finance and property.”
James Mitchell, head of business at the recently formed Heartland Building Society – an amalgamation of CBS Canterbury, Marac and Southern Cross Building Society – says the firm insists on having access to clients’ electronic accounts systems on daily basis.
“We would review client’s debtors’ ledger and pick and choose which invoices we are prepared to lend against,” says Mitchell. “If you are business with significant number of debtors who are hard to identify then it is less likely that you could use this facility from us.
“But if you had single debtor – perhaps [you are] contractor to Telecom – then that would be easy because we consider Telecom to be good risk and likely to pay their bills.”
Mitchell says debtor invoice financing is “operationally intensive” for companies such as his. “Therefore, we have to review the debtors’ ledger and do site visits. There is risk of fraud by firms who may create bogus invoices, draw on the invoice from us and leave the country.”
Heartland uses software system to keep tabs on its clients’ business accounts.
“We are viewing that information every day,” says Mitchell, “so we get to see what is going on within the business. However, it does mean that our clients need to have compatible accounting software – which isn’t generally problem.”
BNZ’s McKerrow emphasises that the invoice financing process strengthens the relationship between bank and client because of the understanding the bank gains of how the business operates – particularly its invoicing and cash-flow management.
“Customers want to know that the banker understands their business; they want active involvement. With knowledge of the inner workings and taking an active interest the banker can add value, further de-risking the business by ensuring it has good robust procedures.”
The BNZ designed and built its own online invoice finance system and believes it has developed potentially market-leading software. It kept it simple; customers only have to supply three files – invoice summary, aged debtor and client contact details.
It has currently matched its system to 35 accounting packages: “We have all the leading vendors on board from MYOB to Xero to Quickbooks and Attache,” and, says McKerrow, they’ll have close to 60 systems matched by Christmas.
“The core target is growth. Many businesses fail because they run out of cash. Our product can solve that by bringing cash forward, funding up to 80 percent of the face value of an invoice out to 90 days; but with the businesses retaining control of the cash collection.”
Unlike BNZ and Heartland, Lock Finance lends against client’s whole accounts receivable ledger.
“As it goes up and down, so our lending rises and falls,” says Thompson. “And it is not obvious to the person [receiving the invoice] that there is anybody funding them in the background.
“We use averaging principles to lend money against the ledger – there’s going to be some good and others [invoices] not so good.
“But we do audit client firms; there are spot checks and we look at client payment history. That gives us comfort on what ratio we will lend – but typically it is 80 percent. Sometimes it is higher, but it can be lower if there is mixed performance.”
Thompson says his debtor financing clients tend to have an annual turnover of more than $30 million, although he has helped companies with annual turnover of less than $2 million – an area where factoring is normally used.
“It is as much about the dynamics of the ledger as the size of it,” he says.
Until now the BNZ’s main invoice finance customers had been SMEs in the $2 million to $30 million turnover category. But its online offering introduced in March targets the medium-sized and larger enterprises with more sophisticated accounting practices. “That’s opened up the $5 million to $150 million turnover group and really there’s no upper limit,” enthuses McKerrow, and it’s working. “There’s been rise in the level of deals through the online offering.”
Because debtor financing isn’t linked to firm’s property or plant, Heartland’s Mitchell says it is ideal for firms in the service industry.
“A good example would be recruitment company; they employ people and lease office space, and therefore have no real business assets,” says Mitchell. “But within their client base they might be recruiting for big players such as Fletcher Building or the city council, for example.”
Heartland’s debtor invoicing facility helped one Christchurch company out of tight spot when its plant and machinery was damaged in February’s earthquake. It needed to get its factory up to speed straight away – well before the expected insurance payout.
“Because it was supplying the major supermarket chains, who are good quality debtors, we were abl