Invoice discounting

3 key takeaways

• Invoice discounting enables businesses to unlock funds tied up in unpaid invoices, providing immediate working capital.
• This service is typically confidential, allowing businesses to maintain control over their sales ledger and customer relationships.
• It is a flexible financing solution that grows with the business, as funding increases with the volume of invoices.

What is invoice discounting?

Invoice discounting is a form of short-term borrowing where businesses use their unpaid invoices as collateral to obtain immediate funds. This financing method helps companies manage their cash flow more effectively by providing quick access to money that would otherwise be locked up until customers pay their invoices. Invoice discounting is typically confidential, meaning that customers are unaware that their invoices have been used to secure financing.

In practice, a business sells its invoices to a financial institution or a specialized invoice discounting company at a discount. The business receives a percentage of the invoice value upfront, and the remaining balance, minus fees, is paid once the customer settles the invoice.

How does invoice discounting work?

1. Issue invoices: The business delivers goods or services to its customers and issues invoices with payment terms, typically ranging from 30 to 90 days.
2. Discount invoices: The business submits the invoices to an invoice discounting provider, which advances a percentage of the invoice value, usually around 80-90%.
3. Customer payment: The customer pays the invoice directly to the business.
4. Balance settlement: Once the customer pays, the business receives the remaining balance of the invoice value, minus the invoice discounting provider’s fees.

Benefits of invoice discounting

• Improved cash flow: Provides immediate access to funds tied up in unpaid invoices, enhancing liquidity.
• Confidentiality: The service is typically confidential, maintaining the business’s control over customer relationships and sales ledger management.
• Flexibility: The amount of funding available grows with the business, as it is based on the volume of invoices.
• No long-term debt: Invoice discounting is a revolving form of financing, meaning it does not add long-term debt to the balance sheet.

Drawbacks of invoice discounting

• Cost: Fees and interest rates for invoice discounting can be higher than traditional loans, impacting profit margins.
• Credit control: The business retains responsibility for credit control and collections, which can be time-consuming and resource-intensive.
• Customer perception: If confidentiality is not maintained, customers may perceive the use of invoice discounting as a sign of financial instability.

Examples of invoice discounting

• Small and medium-sized enterprises (SMEs): SMEs often use invoice discounting to manage cash flow and support growth without taking on additional debt.
• Seasonal businesses: Companies with seasonal sales cycles can use invoice discounting to smooth out cash flow during off-peak periods.
• Service providers: Businesses in the service industry, such as marketing agencies or IT firms, leverage invoice discounting to maintain steady cash flow despite long payment terms.

Invoice discounting vs. factoring

Invoice discounting

• Confidentiality: Typically confidential, with the business maintaining control over customer relationships and collections.
• Responsibility: The business remains responsible for credit control and collecting payments from customers.

Factoring

• Disclosure: Usually involves notifying customers that their invoices have been factored, as the factoring company takes over credit control and collections.
• Responsibility: The factoring company handles credit control, collections, and often credit checks on customers, relieving the business of these tasks.

Related topics

• Factoring: Understand the differences and similarities between factoring and invoice discounting and how each can benefit businesses.
• Working capital management: Learn strategies for managing working capital effectively to maintain liquidity and support business operations.
• Trade credit: Explore how businesses extend credit to customers and manage accounts receivable to optimize cash flow.

Consider exploring these related topics to gain a deeper understanding of how invoice discounting and other financing methods can help businesses manage their cash flow and support growth.