Invoice discounting allows a business to draw money against its sales invoices before the customer has actually paid. To do this, the business borrows a percentage of the value of its sales ledger from a finance company, effectively using the unpaid sales invoices as collateral for the borrowing.
Invoice Discounting is sometimes referred to as Discreet Factoring as it is essentially the same product as Factoring - the business gets cash from its sales invoices earlier than it otherwise would - but the key difference is that the credit control remains with the business owner.
When a business enters into an invoice discounting arrangement, the finance company will allow the business to draw down a percentage of the outstanding sales invoices - usually in the region of 80%. It is possible to achieve a full 100% advance rate but this is typically only seen within the recruitment industry. As customers pay their invoices, and new sales invoices are raised, the amount available to be advanced will change so that the maximum drawdown remains at the agreed percentage of the sales ledger.
The finance company will charge a monthly fee for the service, and interest on the amount borrowed against sales invoices. In addition, the finance company may refuse to lend against some invoices, for example if it believes the customer is a credit risk, sales to overseas companies, sales with very long credit terms, or very small value invoices. The lender will require a fixed charge over the book debts (trade debtors) of the business as security for the funds it lends to the business under the invoice discounting arrangement.
Responsibility for raising sales invoices and for credit control stays with the business, and the finance company will often require regular reports on the sales ledger and the credit control process.
Invoice discounting is targeted at larger companies with established systems and an expected annual sales turnover in excess of £250,000; providers will need to be satisfied that the client can manage their own sales ledger administration and credit control facilities.
- By receiving cash as soon as a sales invoice is raised, the business will find that its cash flow and working capital position is improved.
- Invoice discounting can be arranged confidentially, so customers won’t know that a company is borrowing against invoices.
- The company maintains closer relationships with its customers, because the company is still managing client accounts.
- The business will lose profit from orders or services.
- Invoice financiers will usually only buy commercial invoices - companies that sell to the public might not be eligible
- It may affect ability of the organization to get other funding, as it won’t have ‘book debts’ available as security.
- Once a business enters into an invoice discounting arrangement, it can be difficult to leave as the business becomes reliant on the improved cash flow.
- "Business finance explained". Gov.uk. Retrieved 29 July 2014.
- Smith, Mike. "Invoice Financing, Factoring, Invoice Discounting and Invoice Trading". Retrieved 24 July 2014.
- "Debt factoring and invoice discounting: the basics". Retrieved 2008-11-01.
- ABFA. "Invoice Discounting as a cashflow alternative". Retrieved 2014-02-06.