Invoice Discounting: What are the Advantages and Disadvantages?

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    Invoice discounting is an invoice finance tool that enables businesses to resuscitate their cash flow and jump-start their working capital cycle by leveraging the value of their account receivables. This article examines the pros and cons of this invoice finance facility. 

    Advantages of Invoice Discounting

    Offers quick cash injections that promote cash flow

    Businesses have access to a facility that quickly delivers advance funds once the necessary requirements have been met. They can access the payment within 48 hours in some cases, which is rarely possible when borrowing from traditional finance lenders, e.g. banks.

    • Fast-tracks the working capital cycle: Most businesses that have fewer invoices with individual high value are most likely to benefit since payment problems with just one invoice can have a significant and negative impact on cash flow. Invoice discounting frees up cash that can be used for short term expenses to keep the business up and running on all legs.
    • Businesses continue managing the sales ledger: It is still up to the business to direct credit control measures, manage collections and chase invoices. They have full control over their ledger, and they get to interact and transact with their customers as per usual.
    • Businesses can preserve confidentiality: Customers are not informed that the business has an invoice discounting facility in place. This allows the business to preserve their reputation and to retain trust and forge stronger relationships with their customers.
    • Low-interest costs: Invoice discounting has flexible and lower interest terms that come attached to every advance payment, allowing the business to save and maximize profits at the same time. This is compared to other invoice finance facilities such as factoring.
    • Offers bad debt protection: Invoice discount providers can also extend their services to cover bad debt protection as a free add-on for a specified duration. Bad debt protection is credit insurance that protects businesses from non-payments and customer insolvency.
    • Allows businesses to pay off suppliers quickly: When a business has cash tied up in unpaid invoices, they can experience cash flow shortfalls that restrict timely payments to suppliers. Invoice discounting allows businesses to pay suppliers on time or well ahead of time, which brings its benefits, i.e. early payment discounts.
    • Empowers businesses to expand: Businesses can use the advance funding they receive as a stepping stone to more expansion and growth. 

    Disadvantages of Invoice Discounting

    • Overall high costs: On average invoice discounting has higher interest rates and charges compared to other longer-term, traditional options that include bank loans and overdrafts.
    • Favours businesses with larger turnovers: SMEs may not be eligible for invoice discounting because of their smaller turnovers and finding an invoice discounting provider willing to take the risk is a complicated process that incurs higher charges when accomplished. Most lenders require businesses to have a solid trading history, and customers with a verified credit history and who do not cause problems with invoice payments.
    • Businesses can end up in an Invoice Discounting loop: The advance payments funded by lenders are highly convenient and accessible to businesses. In some cases, invoice discounting is the only viable option businesses have to revive cash flow and replenish working capital. However, business owners can become too dependent on this arrangement which is not healthy for business.
    • Business may be restricted from seeking additional financing options: Invoice discounting is not necessarily a tool that will solve every finance difficulty a business may encounter. Businesses can also seek other finance solutions that require putting up their account receivables as collateral. With an invoice discounting contract, businesses may be unable to access the funding they need.