What is invoice discounting and how does it work?
Invoice discounting enables businesses to gain access to cash tied up in unpaid invoices and to tap into the value of their sales ledger. It’s simple: when you invoice a customer or client, you receive a percentage of the total from the lender, providing your business with a cash flow boost.
One benefit of invoice discounting is that you maintain responsibility for your sales ledger as well as your payment chasing and invoice processing. The main difference between this method and invoice factoring is that your customer is not aware that you have taken on cashflow finance. If you prefer to keep the financial arrangement confidential from your customers, then invoice discounting may be right for you.
With invoice discounting you won’t have to wait up to 90 days to receive payment for your goods and services, and you remain in charge of your own credit control processes, meaning that you continue to chase late payments and therefore your customers are not made aware of a lender’s involvement.
How does an invoice discounting facility work?
It allows businesses to borrow money against the value of their unpaid invoices. Invoice discounting facilities are best suited to B2B businesses that offer long credit terms to their clients.
Invoice discounting can be invaluable to businesses that want to:
- Expand their operations
- Invest in stock, machinery or equipment
- Employ new members of staff
- Fix long-standing issues with cash flow
The invoice discounting process
To explain the process, we’ll pretend that you run a medium-sized manufacturing business that offers 90-day credit terms. Using an invoice discounting facility, you would follow a simple process:
- Supply your clients with goods, and then invoice them as per your normal practices.
- Forward a copy of your invoices to a finance provider.
- After 24-48 hours, your provider will release funds to match a pre-arranged percentage of the invoice’s value (normally between 70-90%)
- When your debtor settles the invoice, your provider releases the rest of the invoice’s value minus a small service fee.
Invoice discounting vs invoice factoring
Invoice discounting is like factoring, however there is one fundamental difference. With factoring, your customers might know that you’re in receipt of finance because the lender will typically manage your sales ledger and credit control processes. As such, they’ll chase any late payments on your behalf. On the other hand, invoice discounting allows you to retain autonomy over all communications and customer service.
What is confidential invoice discounting?
Invoice discounting is normally confidential (it’s sometimes called ‘confidential invoice discounting’), and you’ll continue to deal with customers yourself as normal — your customers won’t know you’re using a finance provider. The downside to this is that you’ll still have to chase invoices yourself, unlike invoice factoring.
What are the advantages of using an invoice discounting facility?
Boosts cash flow
The biggest advantage of invoice discounting is that it can quickly boost cash flow. Businesses up and down the country often struggle with their balance of cash, and much of the time this is not down to poor revenue, but late payments by customers. The idea behind invoice finance is that you no longer need to wait 90 days or even longer for your outstanding invoices to be paid. Instead, as soon as you’ve delivered and raised an invoice, your funder will pay you most of the value of the invoice. Once the customer pays the invoice, you also get the remainder of the value of the invoice, less fees and interest.
When compared with other invoice finance products, discounting carries the benefit of being entirely confidential. Some other products will reveal that you’re using a finance company for your invoices to customers, but with discounting everything is kept between you and your factor. This is ideal if you’re looking to maintain relationships with customers and feel that you have everything otherwise under control.
Requires no renegotiation
Invoice discounting is often chosen as an alternative to other finance products because it’s an ongoing agreement that you don’t need to constantly renegotiate. Unlike a loan, the facility keeps on rolling for as long as you want to pay the account fee. And as your turnover increases, your agreement will automatically change based on what you agreed at the beginning, with different fees and rates etc. Lots of businesses therefore choose to grow with their invoice finance agreement and see it as an essential part of their financial plan.
Isn’t a long-term debt
Discounting is often seen as a less risky form of borrowing, because you’re not borrowing large amounts of money without a clear revenue source in mind. With invoice finance, the money being lent is directly against a specific invoice, which makes it a more manageable type of finance product that can be easily planned for. However, as with any other financial agreement, it’s always worth seeking out the advice of an independent advisor before you decide if it’s right for your business.