Trade and debtor finance: what are they and how do they work?
At Inside Small Business we’re increasingly hearing about alternative funding methods, bypassing the traditional bank loan and the inherent risks this carries for business owners and their families in terms of often having to put their own property on the line as collateral. The terms most commonly cropping up in this area are trade finance and debtor finance. But what are they, and how do they work for SMEs? We spoke to Nick McGrath, CEO of Moneytech, an innovative firm who have been providing these solutions to SMEs for over eight years, to find out.
ISB: First and foremost, what exactly are trade finance and debtor finance?
NM: Trade (or export) finance is an umbrella term that refers to the financing of goods and services used in international trade. When importing goods from overseas, businesses are often required to pay the full sum of the goods upfront, which can often be a strain on already stretched working capital.
Trade finance is a loan that delivers payment to an exporter on behalf of the importer before the goods have arrived. The goods in-transit usually serve as security for the loan, which is usually for a shorter term and paid off once the imported goods are resold. Trade finance instruments can take many forms including letters of credit, export factoring, export credits, insurance or lending facilities.
Alternatively, debtor finance (also referred to as invoice finance, receivables finance or factoring) is a short-term finance solution that releases cash from a business’s outstanding customer invoices.
We help our clients access and move funds as seamlessly as possible via an integrated combination of trade and debtor finance, foreign exchange (FX) and payments automation, through a partnership with end-to-end payments-services provider, Monoova.
ISB: And how do these solutions work?
NM: In Australia, trade and debtor finance solutions are usually offered by banks, non-banks and alternative financiers such as Moneytech. Depending on the lender, the nature of the solutions and requirements may vary, so research is critical.
For example, the trade finance solution we offer is a line of credit with a redraw facility that enables businesses to purchase the stock, goods or materials required in their normal course of business. We can draw from our trade finance facility and pay the supplier 100 per cent of the value of the invoice, at which point the business then has up to 120 days to repay. In most cases, the only requirement to access funding is a copy of the business’s supplier invoice (either local or international).
Our finance solution also works as a line of credit secured against the value of a business’s invoices rather than real estate assets. Funds can be made available within 24 hours of approved invoices being sent, giving access of up to 90 per cent of their cash that would otherwise be tied up for the credit term of the invoices (typically 30 to 90 days).
Often this entire process can take place digitally with the help of technological enablers. For instance, our customers have access to the Moneytech Exchange Platform – a self-service platform where they can upload invoices to secure funding, all the while being supported by a dedicated customer service team.
ISB: What are the benefits of these solutions for SMEs experiencing cashflow problems?
NM: These facilities can effectively alleviate cashflow problems, which we appreciate is a well-documented pain point for thousands of growing SMEs. Prior to the outbreak of the coronavirus pandemic and subsequent shutdowns, Australians SMEs were already struggling with cashflow.
These solutions are designed to minimise the inevitable “cashflow gap”, a familiar concept to business owners, describing the time between the date when a business pays out cash for stock or materials and the date cash is received from customers.
Generally, trade and debtor finance facilities provide a higher level of funding than overdrafts without the need for real estate security, allowing business assets to secure funding. Increased working capital and improved cashflow allows business owners to not only better manage overhead costs, but also meet uplifts in customer demand that previously might not have been possible.
These finance facilities can also be used to avoid expensive early payment discounts with customers. Alternatively, businesses may also be able to claim discounts from suppliers by being able to buy in bulk upfront. This could potentially widen profit margins, thus offsetting the costs of the facilities themselves.
Lastly, these financing options ease pressure from competing variables, all of which could have adverse effects on an SME, from late payments from debtors and bad debts to excess stock and demanding creditors.
ISB: What types of business will benefit from these finance solutions?
NM: They are best suited to businesses that require funding for the purchase of stock, goods, materials or services and may be offering extended payment terms to their customers.
For example, a company that purchases materials or stock/inventory, has a positive tangible net worth in the balance sheet, demonstrated history of profitability and long-lasting supplier relationships would suit a trade finance facility.
We service an ever-broadening client base with these finance solutions across a variety of industries including manufacturing, labour hire and recruitment, transport, mining services, healthcare and construction.
ISB: Are these solutions even more relevant in the current challenging business climate?
NM: SMEs are trying to navigate an unprecedented and extremely challenging business environment, and funding solutions such as these can form a critical part of ongoing business survival.
According to the latest insights from the Australian Bureau of Statistics, seven in 10 businesses reported that reduced cashflow and reduced demand for goods and services are expected to have an adverse impact in the next few months. Trade and debtor finance solutions can be used to future-proof business operations ensuring that sufficient liquidity is maintained to cater for the peaks and troughs now and into the future.
Uncertain business environments can also have a flow-on effect on the property market. Slumping housing values have the potential to put a director’s personal property at risk and, therefore, negatively impact property-secured working capital lines. Given these solutions provide businesses with the vital working capital lines required without real estate security, the exposure of the business to an unhealthy property market is lessened.
ISB: Could you give us an example of how trade and debtor finance has improved outcomes for one your SME clients.
NM: A manufacturing business came to us via our extensive referral partners network. Despite being an established business with a strong track record of 20 years, they were operating under new management and experiencing difficulties with securing additional funding. Under new management, business growth was at 20 per cent every month and a large proportion of the business’s working capital was tied up in stock, materials and outstanding customer invoices. The business had exhausted every avenue in sourcing an increase to their unsecured business overdraft through their bank.
We were to provide them with a $500,000 debtor finance solution, allowing access to 90 per cent of the value of their outstanding invoices. The ability to free up cash provided the directors with the peace of mind that they would be able to meet customer demand and pursue growth opportunities – without real estate security, lock-in contracts or early termination fees.
This story first appeared in issue 29 of the Inside Small Business quarterly magazine