Invoice Discounting is a form of invoice finance, or accounts-receivable finance, where an unpaid invoice is sold for a percentage of its value.
Read on to learn about how this popular form of invoice finance can improve your cash flow cycle and make a dramatic impact on working capital.
Invoice Discounting: Definition
Invoice discounting is an invoice finance facility in which a company’s invoices are used as collateral for a short-term business loan.
You, the borrower, approach an invoice finance provider with the unpaid invoices you need a cash advance for.
The lender assesses the level of risk based on a range of factors, but largely the credit strength of the companies with outstanding invoices.
On that basis, the business finance provider offers terms which will include how much money you’ll receive immediately, and what their fees are for providing the service.
It’s that simple.
What is the Difference Between Invoice Discounting and Factoring?
Unlike invoice factoring, the other popular form of invoice finance, discounting allows the borrower to retain control of the sales ledger, meaning the clients needn’t known an alternative finance process is in place.
This is why the the process is sometimes known as discrete invoicing, as opposed to traditional invoice factoring.
Because the lender has no personal contact with your customers, its seen as slightly higher risk than invoice factoring. As such, most lenders offer discounting facilities to businesses with a minimum turnover of 100k.
If you’re not in that category, you’re better of trying invoice factoring as a means to finance invoices.
Why Use Invoice Discounting?
A Discounting facility is a useful invoice finance solution for businesses which need to improve their cash-flow cycle quickly but want to retain control over the customer relationship.
For companies with a large number of clients owing low-value invoices, it wouldn’t be ideal in most situations. But where there are fewer clients, owing large amounts of money, poor cash flow can push a company to the brink of insolvency. In this scenario, invoice discounting can quickly provide an influx of cash and, ease the worry of late paying clients.
It is also available to many businesses that have been refused traditional bank finance since the risk assessment is weighted more towards the company owing the invoice, than the one requiring the discounting.
Confidential Invoice Discounting
Most invoice discounting is, by definition, confidential since the customer doesn’t need to know there’s a finance arangement in place.
However, some lenders choose to market this with the term ‘confidential’ front and centre as a selling point.
In actual fact there’s no difference between this and regular invoice discounting. You will retain control of the sales ledger unless its contractually disclosed otherwise.
Disclosed Invoice Discounting (DID)
Disclosed discounting bears similarities to factoring in that, where the lending partner feels the risk is too high, they insist on collecting the invoice themselves.
With this type of arrangement, you lose control of the sales ledger which can actually have it’s advantages since collecting invoices can be a drain on resources. Invoice discounting companies are highly efficient at managing credit control and invoice collection.
DID means that invoices would be sent out to customers bearing a note that explains ‘this invoice has been assigned to our invoice discounting partner’. DID also differs from conventional discounting in that is bears a high cost due to increased administration.
Is it Expensive?
While short term finance is always more expensive than longer term loans, discounting is an industry that has grown exponentially over the last few years, meaning prices are becoming ever more competitive.
Usual costs include discount fees, service charge, and optional credit protection. Since discounting is usually offered on a contractual basis, costs may also be incurred should you choose to terminate your agreement before the agreed contract end.
We strongly recommend due diligence before signing up with any provider since this remains an unregulated industry.
Is Invoice Discounting a Loan?
Technically the short answer is no as the assets are sold and bought. However, in practice invoice discounting could be thought of as an asset-based loan – effectively a very short term form of borrowing where the accounts-receivable are used as loan security.
For many businesses it becomes a normal part of standard business operations, with the costs simply factored into overall profit margins.
Can I Discount a Single Invoice?
Single invoice discounting is something certain providers now provide as Selective Invoicing.
This can be a useful invoice finance solution when a company is waiting for the payment of one large invoice but doesn’t want to be to be tied into a long-term contract.
What’s the Invoice Discounting Process?
- The company in need of finance selects a lending partner and, assuming the criteria is met, sign an agreement.
- (2) Partner pays an advance of typically up to 80% on invoices which have been sent out, sometimes as quickly as 24 hours. Depending on the factor the advance can be up to 100%.
- (3) At the end of the payment term, the lending partner may be paid via a discrete method or collect the payment from a special company bank account.
- (4) Once the invoice has been settled, the partner will pay the balance, minus the agreed fees.
- A source of fast cash-flow that can improve the working capital cycle
- Available to businesses who may have been refused traditional bank finance
- Does not require a company to own tangible assets as security
- Discounting is only offered for commercial invoice payments, which means this form of finance wouldn’t be available to businesses that deal with the general public
- You wouldn’t receive the full percentage of your invoices
- Discounting (as opposed to factoring) is generally only available to businesses which a proven credit-collection process in house.
What are the Best Invoice Discounting Companies?
If you want to know whether your business could access discounting, and which providers offer the most competitive rates or fees, you might try Business Expert, which offers a real-time comparison engine using every major UK discounting company. You can find their website here.
What is an Invoice Discounting Drawdown?
In the factoring world a drawdown is simply terminology for the funds received up front. So a typical drawdown would be between 60-80%, depending on your credit situation.