Invoice discounting is a financial service allowing a company or an organisation to borrow money up to the amount of its unpaid invoices.
It can be difficult for most of the suppliers to manage their finances because of the extended payment dates for invoices. Due to their short or bad credit histories, many suppliers struggle to be approved for bank loans.
Nevertheless, a supplier may submit an application for invoice discounting from lenders who will take unpaid invoices as evidence of money owed. With the invoice(s) serving as security, the lender will give the supplier a payment advance. The supplier delivers the borrowed funds to the lender on the due date along with a pre-agreed service fee.
Steps to follow for invoice discounting:
- A supplier offers products to a buyer and issues an invoice with, frequently, up to 120-day delayed payment terms.
- The supplier requests a short-term loan from an invoice discounting platform because they need working cash, and they use the invoice as security.
- The provider of invoice discounting assesses the invoice and the buyer’s creditworthiness before agreeing to advance a portion of the total invoice amount as a short-term loan.
- A pre-determined cost (1% to 3%) is charged by the provider.
- The buyer settles the invoice within a time period of 120 days.
- The supplier reimburses the invoice discounting platfrom for the borrowed funds and the pre-agreed service fee.
Benefits of invoice discounting:
Invoice discounting paves countless benefits for small and medium-scale businesses. Here are a few:
- Invoice discounting gives quick access to working capital, otherwise it could tied up in the unpaid invoices.
- Instead of long-term forecasts and credit history, finance approvals are based on the individual invoices.
- There is an improved cash flow for all the suppliers to invest in a company or pay their own suppliers.
- In general, discounting fees never exceed 1 to 5% of the total invoice amount.
- Businesses are not subjected to high-interest repayment and long-term agreements.
- Usually, the process of invoice discounting application is very simple and quicker than bank loan application process.
- Moreover, invoice discounting is confidential.
Invoice discounting: A good choice to grow your business
- Rapid growth: Working capital is very much needed for financing new machinery, buildings, and personnel. Instead of waiting weeks or months for invoice payments, businesses can obtain cash fast by using invoice discounting.
- Frees up cash flow problems: Businesses can get rid of all the problems related to working capital to cover expenses.
- Best option for loans: Due to a short or bad credit history, many suppliers may simply be rejected for bank loans. If a supplier does obtain a bank loan, it frequently has stringent repayment terms and high interest rates that are challenging to commit to. When an invoice is paid, the situation is resolved and cash is provided to pay amounts that are already owed to the supplier.
What is meant by confidential invoice discounting?
Using a credit source without disclosing it to the buyer is known as confidential invoice discounting. This is beneficial for suppliers to keep their relationships with buyers without having an outside lender.
One of the major drawbacks of confidential invoice financing is that the supplier can exclusively in charge of pursuing the buyers with regards to unpaid invoices. In contrast, the finance provider takes on the burden of pursuing the buyer for money frequently in some other financial agreements like non-recourse invoice factoring.
What is meant by selective invoice discounting?
In the process of selective invoice discounting, the suppliers can select specific invoices for submitting finance reports. Besides, it also allows the suppliers to access working capital.
Differences Between Factoring and Bill Discounting
Two crucial short-term invoice financing methods that meet a company’s funding requirements against delinquent payments are factoring and bill discounting. However, these concepts operate differently, therefore it is crucial to comprehend how they function.
While both factoring and bill discounting offer quick access to money held in outstanding bills.These distinctions are based on who owns the invoices, who is in charge of collecting payments, and how much the financial institution is involved. In order to choose the best financing solution for their particular needs and circumstances, firms must be able to distinguish between these differences.
Factoring: A business sells outstanding invoices to a factoring agency as part of the factoring process, which is distinct from the discounting of bills of exchange. A factor holds the complete credit control procedure after purchasing the unpaid book of ledgers and is paid directly by the clients.
When businesses choose to use factoring as their invoice financing option, they frequently receive a lump sum of up to 80%. This assists funds from bad debts in addition to helping an organisation meet its financial obligations.
Bill Discounting: Businesses approach a trade financing organisation to produce funds against unpaid bills through the procedure known as bill discounting, sometimes known as invoice discounting. By enhancing cash flow management, this invoice discounting strategy aims to hasten a company’s working capital.
This invoice discounting procedure keeps all customer information totally private. Additionally, invoice discounting is a simple withdrawal of money with the option of a quick repayment period. Additionally, import and export invoice discounting is one of the most popular options for importers and exporters due to its speedy and simple processing.
Factoring vs Bill Discounting:
Here are some of the differences between factoring and bill discounting:
|Nature||A procedure whereby a business sells unpaid invoices or book debts to a financial company.||Businesses exchange invoices with finance organisations in order to receive payment against those.|
|Credit control||Factors acquire total credit control through this process.||No credit control authority is granted to the invoice discounting companies.|
|Funds received||A company can receive up to the amount of the book debts in factoring.||The creditworthiness and accounts receivable of a business determine how much it can borrow from trade financing companies.|
|Parties involved||Parties that are involved in factoring are debtor, factor and client.||Drawer, Drawee, and Payee are the parties engaged in the invoice discounting process.|
|Confidentiality||Since clients pay the factors directly, the factoring procedure does not entail any level of confidentiality.||Customers of a business are unaware that a invoice discounting company is involved because invoice discounting service providers preserve complete confidentiality of the deal.|
|Type||Both recourse and non-recourse||Recourse|
|Governing body||It is not specified under any act||It is specified under Negotiable Instrument Act 1881|
|Suitability||For small and medium-sized enterprises, factoring is suitable.||Invoice discounting works well for large and medium-sized businesses.|
Businesses can use the information in the table comparing invoice discounting vs factoring to help them choose depending on any of the aspects. Along with this, some additional major factors that are essential to comprehending the applicability of both notions include:
- Present status showcasing financial needs
- Size and nature of the business
- Resource optimisation
- Credit control ability
Before investing in invoice discounting, it is important to thoroughly research and understand the specific terms, conditions, and risks associated with the investment. Consulting with a financial advisor or professional with expertise in invoice discounting can also provide valuable guidance to make informed investment decisions. Hope this article helps you 🙂
Guest article written by: Anji Velagana, a graduate in Electronics and Communication Engineering from Jawaharlal Technological University, Kakinada. He has 5 years of experience in content writing. He is currently working as a Digital Marketing Analyst and Content Contributor for Falcon Invoice Discounting.