As saying goes with any business venture, Sales are Vanity, Profit is Sanity and Cash is Reality, and the ability to finance it is a crucial reality of its existence. In Recruitment, particularly if your business is going to provide temporary/on-hired placement services, you are likely to need access to finance to support the business as it grows.
There are a variety of options for financing a recruitment business but not all of them may be available to a start up business.
Realistically, getting a bank overdraft for a start up business is likely to be difficult as Banks tend to require a proven (eg 2 years +) trading history prior to considering an overdraft. In addition to this they will generally require security, both over the business and over property (eg your house).
Both Banks and Non-Banks (eg specialist Debtor Finance Companies) can provide debtor finance options. Again, banks are generally going to require a good trading history (and probably security over property) but could be a cheaper option in the long term. Specialist Debtor Finance companies are generally far more flexible in regard to trading history and generally do not require as much security (eg over property) but, as they are taking a greater risk, the cost can be more expensive than a bank.
Debtor Finance is very much suited to the Temporary/On-Hire Recruitment business as it is a means to get funds on the basis of invoices that you raise so these available funds grow as your business grows.
Broadly speaking there are two types of debtor finance solutions;
- Invoice factoring: Provides funding, along with credit collection – ie your customers pay the Debtor Finance provider directly
- Invoice discounting: Provides funding and you undertake your own credit collection
The way that Debtor Financing works is that upon creating the invoice (and presenting it to your Debtor Funding provider) they advance you a percentage of the value of the invoice. This percentage can vary but is usually in the vicinity of 80% to 90% of the full value of the invoice. Then when the client pays their invoice the Debtor Funding provider pays you the balance of the invoice less their fee.
Things to consider;
Generally the financing fee is based on a percentage of the invoice – so for example (and not implying what a typical cost may be) if it cost you 5% to fund an invoice and your gross margin on temp supply is 10% (before funding the invoice) then your gross margin is now 5%. It is worth considering this as sometimes people confuse what the % cost means – eg when considering a bank they might charge you an annual percentage based on the total funds you borrow over the course of the year.
So imagine a business turning over $1.2 million a year and in doing so they need to have a loan facility of $100,000 – ie this would be used fund their needs throughout the year and the balance owed would go up and down but never exceed $100,000. If they paid 5% interest per annum for this and the average balance owed was $100,000 then it would cost $5,000 in interest. Take the same scenario but instead of borrowing $100,000 they use debtor financing and the rate is 5% of the invoice value then the cost for funding in the year would be $60,000 (ie $1.2 million x 5%). Note: in these comparisons we have used the same % value to illustrate the point about the differences in how the cost is calculated – rather than giving an estimate of what each type of funding may cost you.
Other things to consider with Debtor Funding is that generally an invoice is only financed for a period of 90 days – so if you have not been paid by you client within that time frame then the invoice is no longer available to finance. There are some providers who offer non-recourse financing – which means that if the client does not pay then it may not effect you.
Finance costs can have a significant impact on your business and quickly erode margin. Additionally, as mentioned earlier “Cash is reality” and so an area that you should always focus on is the speed at which you are able to get your clients to pay you and ensuring that you have both good credit checking processes and credit collection processes in place.