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Debtor Finance Pt 2 - What you need to know before it goes wrong

If you are considering Debtor Finance, Part 1 focused on the preparation and education required before implementation. See Part 1 Review.


From my business restructuring and business recovery experience I have seen a pattern of common mistakes and procedural failures in administering Debtor Finance and could not find any articles flagging this, so here is an opportunity to learn from real examples.


Part 2 will summarise the disciplines and processes required to maintain the benefits of Debtor Finance, after you commit, and using the experience from these examples you can see what can go wrong when certain disciplines and processes are not maintained to a satisfactory level. If you believe your processes are sound, review these examples to verify.


WHAT TO DO ON STARTING UP THE DEBTOR FINANCE FACILITYAT SET UP

  • Ensure dedicated staff are shown and trained on the Lender’s web based software on your site with your computer equipment. Ensure staff backups and a management representative are involved in this training.

  • Ensure staff in contact with customers are informed and educated on the Debtor Finance introduction and the business benefits, to intercept any misunderstandings or speculation from either side.

  • Ideally set up a specific bank account for the draw down facility. This will make reconciliations easier, and the account will show as a negative on the balance sheet “current assets” when drawn down.

  • Implement Debtor insurance if it is a Lenders condition, and review and consider implementation if it is not a condition.


DURING THE MONTH

  • The web technology allows for more than one approving party to process a draw down - use this functionality so a second person in authority or experience can maintain the overview and internal critique.

  • Have a clear list of which customers are excluded from the Debtor Finance facility. This should be defined by the Lender. Inter-company and related parties are excluded from draw downs.

  • The mathematics involved in the Debtor Finance facility can be easily supported by an Excel worksheet to correctly calculate what cash is required and available to draw down, (after applying exclusions, adjustments, credit notes and provisions), and where the threshold or date for the maximum allowable draw down will occur. Why draw down extra cash and pay interest if you do not need the cash this week? See example Excel worksheet.

  • If a cash flow forecast model is in place, and it should be if the business has had cash flow challenges, then the Excel work sheet will assist as a bridge to define the cash available for input into the cash flow forecast model after draw down. See example Excel worksheet.

  • The cash flow forecast accuracy can be improved by effective consultation with Purchasing Officers, Accounts Payable, Sales and Project Managers on the timing and values, on a frequent basis, e.g. monthly or weekly. This will further improve the information required to determine the Debtor Finance draw down required.

  • Calculate the interest deduction provision within the model as you go and adjust at month end from the statements, so the projected cash available for operations is not over-stated.


AT MONTH END

Most Debtor Finance Lenders require a reconciliation at the end of each trading month. While this should be done daily within the business, procedural issues and corrections “may” get flushed out at month end.


For example, proper reconciliations and reviews should highlight the following:

  • If customers have exceeded the Lenders set credit limits (typically 90 days), the “available draw down” amount may reduce to contain their risk.

  • If credit notes have been issued to the customer, they need to be applied also through the Debtor Finance facility.

  • Non-approved customers or related entities should not have been invoiced through the facility, and will be reversed, which will reduce the remaining funds available.

  • If customers have gone into Administration or Liquidation, they should be disclosed to the Lender and work through a practical transition solution. If debtor insurance was not in place, the amount drawn down has to be paid back or consolidated into the adjusted available remaining draw down. Non-paying customers are still a company problem and have to be monitored and expedited with or without Debtor Finance.

  • A reconciliation of the Debtor Finance provider’s records and company bank accounts should balance; investigate and resolve if not in balance.

  • Do not preinvoice, or invoice non-commercial transactions, as random audits and month-end audits will eventually pick this up – this is a breach and facility default condition with potentially serious implications.

Note: The message here is do not consume or draw down what you know you are not entitled to.


Note: Depending on the value of these issues, it is possible that the company may have overdrawn its entitlements and will owe back to the facility, or the funding may cease until the disparities self-correct from future debtor receipts. This means a period will occur when no cash flow comes into the business.


MONITORING DEBTOR FINANCE

The following are tips on good practice to manage, monitor and control the administration of Debtor Finance, to ensure continued reliable cash flows from this facility.

  • Have back up staff trained to do the Debtor Finance draw downs and bank reconciliations. Ensure leave plans are monitored to anticipate this. Rotate staff in this role to keep alert and to provide peer reviews. Do not leave the whole function to one person; as illness, personal emergencies or sudden unexpected departures can occur.

  • Management, or a person in authority or experience with an understanding of the process, to be an internal approving party in the web draw down process.

  • Monitor and expedite slow paying customers – stop supply in extreme cases. Just because cash was drawn down on invoicing should not reduce the diligence to monitor accounts receivables.

  • Ensure a Debtor Finance spreadsheet is used and maintained daily to assist the traceability link between the facility, your bank account and the cash flow worksheet inputs. Calculate and make provision for the interest, charges, adjustments and exclusions. See example worksheet.

  • Draw down on the debtor finance facility only when you need it – why pay extra interest if you do not need to?

  • Ensure monthly management financial accounts are done timely, accurately and every month.

  • Ensure key files are backed up regularly. Include backing up key finance files on mobile office equipment on the office network – verify this has been done.

  • If you need to rush Debtor Finance invoices through each week to ensure you have cash to pay the wages, then take the hint and implement effective corrective action to identify and resolve what is causing the cash short fall.

  • Ensure debtor credit notes are also applied to the draw down facility.

  • Do not invoice non-approved customers, related entities or any of the Lender’s excluded parties.

  • Do not pre-invoice for work not-earned or where the customer has not agreed to be invoiced.

  • Just because the Lender may have done an audit and nothing was detected, does not mean your system or management process is sound. If the auditor missed a breach or transaction error, the underlying problem is still with the company not the Lender, and the audit is not a defense.

  • Ensure debtor finance monitoring reviews are on the Board or risk management committee agenda.

  • Develop and maintain a simple KPI dash board monitoring key financial and operational ratios – this will provide improved visibility and understanding of key drivers and related affects. See some working examples.

If these basic and prudent disciplines are maintained, then the accelerated cash flow benefits from Debtor Finance will be achieved and sustained with no surprises or adverse cash flow corrections.


WHAT HAPPENS IN DEBTOR FINANCE AUDITS AND IF DEFAULTS OR BREACHES OCCUR?

Usually if a procedural issue exists it will occur or develop within the first year. Some Lenders may do audits annually but this is too long to wait for someone to discover issues – a lot of damage could have progressed (e.g. incorrect draw downs), and some companies have not been able to recover from this because the cash had been consumed.


Audits usually check random transactions, evidence of controls and reviews, validity of invoices and amounts, and verifying if non-approved customers have been included etc.


Always be transparent and honest with your issues and disclosures to the Lender. If you have been, and if issues arise, you are more likely to get support or concessions to work through the issues. Conversely if the facility has been manipulated, information withheld, or false claims made, then the Lender will enforce the agreement conditions and abrupt stops to cash flow can occur.


In the event that the facility has been overdrawn, and based on the cause and the quantum, and the risk exposure to the Debtor Finance Lender, typical tactical responses by the Lender are:

  • Ceasing any further draw downs until the debtor arrears are paid (to the Lender) to bring the outstanding amounts back into the approved facility limits.

  • Converting the arrears into loans, usually at higher interest, with this then showing on the balance sheet "liabilities".

  • Arranging for an independent Investigative Analysis review on the business, where adverse findings may trigger other events.

  • Enforce Director Guarantees or Personal Guarantees, increasing personal liabilities.


SUMMARY

Part 2 has drawn from real examples to provide a checklist on processes and controls that should be in place to manage the business, and to provide an effective framework to better manage Debtor Finance and cash management.


If these processes and checks are followed then the accelerated cash flow from the Debtor Finance facility will continue to provide the original benefits, with no surprises.


If business conditions adversely change, act early and seek additional independent professional advice as required.


If you are aware of other procedural failures or additional disciplines required to maintain or improve the control of Debtor Finance, please feel free to share them in the Comments response, so others recipients can learn from your experience.

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