Invoice discounting gives you access to the money in your accounts receivable ledger – unpaid customer invoices – much faster. Instead of waiting for your customers to pay your invoices, you take out a short-term loan from an invoice discounting company. These companies will lend you up to 95% of the value of the invoices, paying you the money in a matter of days rather than weeks. Once you receive payment from your customers, you pay back the loan.
Invoice discounting is a method of invoice financing. It’s different to invoice factoring in several ways, one of the main differences being confidentiality. Your customers need never know that you’re using invoice discounting providers, whereas invoice factoring is usually harder to hide.
How does invoice discounting work?
Invoice discounting is like having an overdraft facility or a series of short-term loans secured on your accounts receivable ledger. This is how it works:
You sell goods or services to your customers as usual.
An invoice discounting company lends you the value of the raised invoices, minus a small percentage, after verifying that the invoices are valid.
Once you've received payment from your customers, you repay the loan to the invoice discounting company, plus an agreed fee to cover costs, risk and interest. The fee is usually between 1% and 3% of the invoice total.
You raise invoices for those goods or services and send them to your customers.
Your customers pay you according to your normal payment terms (it's your responsibility to chase late invoice payments – you remain the credit controller).
In some cases, your customers might pay into a trust account in your business name but actually controlled by the invoice discounting company. This reduces the risk of non-payment by you to the lender yet maintains confidentiality.
The advantages of invoice discounting.
The big advantage of invoice discounting is that you know you’re going to get paid quickly. This makes a big difference to your cash flow, especially if you have clients who normally take a long time to pay. Cash flow is vital to the health of your business so the better your cash flow, the more likely it is that your business will survive and thrive.
Another advantage is that invoice discounting finance is usually cheaper and simpler than applying for a bank loan – and you’re more likely to be approved. With an invoice discounting service you should also have a more predictable revenue stream. This makes it easier to do business planning and forecasting, which in turn may allow you to take advantage of new investment opportunities.
The money you obtain via invoice discounting could be used in all sorts of ways: to take on temporary staff during a seasonally busy period; to buy more stock or raw materials; to carry you through a tough trading period; or to invest for the future.