What Is invoice discounting?
A way for your business to gain alternative finance, invoicing discounting allows businesses to leverage unpaid invoices as a way to receive immediate funds.
Invoice discounting is a relatively risk-free way for business owners to receive working capital finance from third parties by using their unpaid invoices as collateral.
By essentially selling your unpaid invoices and leveraging your sales ledger, you as a business owner can get short-term loans and access to cash in advance with existing invoices acting as security for repayment of funds.
How does invoice discounting work?
Invoice discounting is a form of finance opportunity that is commonly used by a multitude of sectors, particularly those that need working capital before a job is complete, such as the construction and manufacturing industries, printing companies and transport services.
In order to receive the funds from the third-party lender, you as the borrower will need to supply an accounts receivable report and this data will be used to determine which invoices can be discounted and the total loan that can be issued.
You as the business owner will still be responsible for collecting funds from your customers and chasing the necessary invoices.
Through invoice discounting you can expect to pay an interest rate of between 2-3% more than normal bank base rates, while management fees will also apply as may additional termination costs.
The benefits of invoice discounting
Through invoice discounting, businesses can access a range of benefits that you wouldn’t typically see from traditional bank loans or overdraft facilities. Here are just some of those benefits:
- Supplies your company with instant cash flow, bolstering your Working Capital Cycle when needed.
- No need to wait for your customers to pay large invoices.
- You will receive funds on a flexible schedule when needed as you adapt the lending structure to the cyclical changes or growth in your company.
- No need to leverage company or personal assets before the necessary funds are released.
- Get access to working capital even if you have poor credit scores or have been refused loans in the past.
- Retain confidentially with customers who don’t need to be notified of the company’s financial status in order for the transaction to take place.
- Get more flexible cash than traditional loans allow.
Things to bear in mind when invoice discounting
While the risk of invoice discounting is limited as you as a business will know who has been invoiced and when they are likely to pay, there are some things you need to bear in mind when embarking on this process for your company.
Always ensure that there is no history of late payment on the customer invoices your business plans to leverage to ensure that you will receive full payment and will be able to pay back the loan.
As this is a short-term funding solution it’s advisable that you structure your company’s finances such that your business is not reliant on Invoice Discounting but rather only uses the service in necessary growth situations.
Most invoice discounting contracts do have a recourse clause that will allow the lenders to assert their rights to reclaim any funds which have been provided, even in the case of defaulting customers.
Is invoice discounting suitable for your business?
Invoice discounting is a good choice for established companies that have the necessary credit control systems and a reliable customer database that regularly and consistently pay their invoices on time.
It is also a good choice for brands that can wager higher profit margins, with the higher interest of invoice discounting making less of a difference to the bottom line, allowing these companies to take the leap on bigger contracts without having to worry about the working capital.
You will also need to supply the lender with annual and monthly turnover reports, and these will need to be consist and exceed a minimum threshold, thus invoice discounting is not a great choice for new businesses.
What is the difference between invoice discounting and factoring?
While invoice discounting allows you as a business to collect customer payments yourself and thus retain confidentiality, if you are unsure that the customers will in fact pay the necessary invoices then invoice discounting is likely not the best solution for you. In this case, it may be better for your company to consider invoice factoring.
Through invoice factoring, the third-party lender will take over your invoices and as a result will chase and collect any late payments from your customers. Through this method, defaulting clients are dealt with, however customers will also be aware that a finance arrangement is in place for the brand.