Invoice discounting is where a company’s unpaid invoices serve as collateral for a loan. Businesses can enhance the value of their sales ledger by using invoice discounting providers.
You can also access the money in your accounts receivable ledger – unpaid client invoices – much faster. Instead of waiting for your clients to pay, you can take out a short-term loan from an invoice discounting provider.
How is Invoice Factoring different?
- Invoice factoring is a sort of invoice financing in which you may “sell” part of your outstanding invoices
- An outstanding invoice is a sales invoice delivered to a client and is currently awaiting payment
- Invoice factoring can help businesses with many outstanding invoices overcome cash flow problems and increase revenue stability
In invoice factoring, the client is aware that the invoice is being factored, whereas, in invoice discounting, the client does not know the invoice has been discounted
How does it work
- A company sells a product or offers a service to its customers.
- The seller invoices the client and gives them up to 120 days to pay
- The invoice is then sent to a third party, commonly referred to as a finance firm.
- The financing company purchases the account receivable from the business. Funds are accessible at a certain percentage of the invoice’s face value (80%).
- When a client makes a payment, the remainder of the invoice is refunded to the business, minus a service fee
Once the lender receives a copy of an invoice, the pre-agreed-upon share of each invoice is paid into your bank account. The money can then be used to pay bills, settle debts, or as part of a long-term growth strategy.
Sending out invoices as soon as you fulfil your services is essential to succeed in invoice discounting since it provides a consistent stream of income throughout the month. Once the agreed-upon percentage of each invoice is paid – often about 80% to 90% of the total – you collect payment from your customer as usual.
Fees are subtracted from the remaining balance and either returned to or claimed by the lender. Charges, as well as any other invoice discount terms, should be transparent, and the charge structure should be made clear by the lender. This allows you to budget more efficiently and make the greatest use of your money.
Is Invoice discounting right for you?
With so many different financial choices now available, it can be tough to determine which one is best. Invoice discounting may be a suitable option if:
- Your credit control procedures are solid and effective
- You don’t have many bad debts
- In general, your clients pay on time
- Customers have a minimum of 30 days to make a payment
- You fulfil the lender’s minimum turnover requirement
- One of the most important factors to consider when choosing an invoice finance facility involves handling credit management in-house. If not, invoice factoring may be a better option.
- Cash flow is increased by releasing money held in overdue bills.
- A company does not need to hold any high-value assets – There are no collateral assets required.
- It is offered to both large and small businesses that have previously been rejected by traditional bank financing.
- The financing firm adjusts to the business’s requirements, providing a flexible finance solution.