Funds for businesses often come from sales income or invoices and bills from clients and customers. Companies may use the funds to finance the purchase of new machinery, maintain business operations, or recruit more staff. Receiving money might occasionally take longer, which can have an impact on operations or company choices. Instead of typical loans, you may use invoice discounting to get funding more quickly.
In this post, we will define what is invoice discounting, examine its advantages, provide an example of how it functions, and discuss the reasons why you could use it at work.
What Do You Mean by Invoice Discounting?
What is invoice discounting? A supplier of invoice discounting, a financial service, loans money to a business up to the amount of its overdue invoices.
Many foreign vendors have to deal with postponed invoice payment periods, which are sometimes up to 120 days and can be difficult on their budgets. Due to their short or bad credit histories, many suppliers also find it difficult to get bank loans to help with their cash flow.
Lenders who accept unpaid invoices (accounts receivable) as evidence of money owing, however, may grant invoice discounting if a supplier applies. The invoice(s) will be used as security by the lender for the cash advance to the supplier. On the due date, the supplier delivers the borrowed funds to the lender together with the pre-agreed service charge, and the buyer settles the invoice.
Features of Invoice Discounting
As per the invoice discounting meaning, the following are its features:
- Interest rates and loans against invoices are contingent upon the terms of the transaction as well as the size and volume of the business.
- In this context, invoices used as bills are also referred to as bills of exchange.
- The lender charges the interest amount in advance from the buyers.
- Bills can be employed to secure loans of up to 90% of the invoiced amount from the lender.
- The credit period for this process is contingent upon the buyer’s creditworthiness.
- Borrowers can access immediate funds during financial emergencies.
- These bills or invoices serve as a form of bank overdraft, with interest being levied only on the utilised loan amount.
- The bills should have a validity period of at least three weeks to 3 months.
- Invoices can be presented in two forms: With Resource, where the seller’s bank verifies all documents and terms, and Without Resource, which involves no such checks.
How Does Invoice Discounting Work?
An overdraft facility or a series of short-term loans secured by your accounts receivable ledger are comparable to invoice discounting. The process is as follows:
- You maintain the sale of your products or services to your customers.
- Invoices are generated and dispatched to your clients for the products or services provided.
- Upon verifying the authenticity of these invoices, an invoice discounting provider advances you the value of the issued invoices, deducting a small percentage.
- Your clients make payments as per your usual payment terms.
- Once your clients have settled their invoices, you repay the loan to the invoice discounting company along with an agreed-upon fee, which covers expenses, risk, and interest. This fee typically falls within the range of 1% to 3% of the total invoice amount.
- In certain cases, your clients may make payments to a trust account bearing your company’s name but overseen by the invoice discounting service. This arrangement safeguards confidentiality while reducing the risk of default to the lender.
The Advantages of Invoice Discounting
Invoice discounting or invoice financing, provided by all renowned credit institutions such as banks, NBFCs, and supply chain finance firms, has several advantages.
Here is a look at the most notable advantages of invoice discounting.
Through invoice factoring and invoice discounting, invoice discounting businesses provide quick cash. The invoice discounting technique, which uses unpaid invoices as collateral, disburses short-term funding more quickly than traditional corporate loans. Additionally, sales receivables provide a speedy infusion of cash to satisfy working capital requirements and complete important tasks.
Increased Cash Flow
One can use the money in transit much more quickly than business loans like term loans or secured company loans. An invoice discounting company’s procedures are swift and efficient since they are exclusively for obtaining rapid cash to increase cash flow, increase working capital, and maintain business operations.
Release Locked Cash
Cash stuck in a company’s supply chain gets released through invoice discounting. A supplier of invoice financing makes loans based on legitimate client invoices, converting accounts receivable into quick cash.
Use Cash for Any Purpose
When it comes to carrying out high costs and investments, keeping a healthy working capital cycle, and boosting cash flow, invoice financing offers a simple, adaptable solution for company financing that enables companies to get immediate cash for a variety of uses.
There are no substantial collateral requirements or guarantors of any type for invoice discounting. Companies do not need to pledge any real estate, stock, equipment, or similar assets. To apply for rapid business loans from discounting businesses and credit institutions, they simply need to have their commercial invoices prepared.
Unlike invoice factoring, which takes charge of a company’s sales ledger and goes about collecting payments for the accounts receivable invoice discounting providers do not do this. Instead, everything stays secured under wraps, enabling corporations to keep their operations hidden from customers.
Grow Credit Sales
One of the most notable benefits of invoice discounting is the increase in credit sales. The simple accessibility of such rapid financing solutions gives firms the confidence to operate on credit, but with dependable partners and consumers who meticulously fulfill their financial responsibilities. Discounting invoices speeds up business operations and fosters further expansion by converting the aforementioned credit into liquid cash.
How do I implement invoice discounting?
As per the invoice discounting meaning, the initial step involves deciding whether you wish to discount your entire accounts receivable ledger. It is often referred to as whole turnover invoice discounting. You can also opt for the selective invoice discounting route, where you discount only specific invoices. It’s worth noting that for smaller businesses, selective invoice discounting might not always be a viable option due to the preference of invoice discounting companies to diversify their risk across a broader spectrum.
Subsequently, reach out to several invoice discounting providers and conduct a thorough comparison of their services and associated fees. If possible, request anonymous references from their clients, which can still be beneficial in aiding your decision-making process. Consulting with your accountant before finalising your choice is also advisable, as they may offer valuable insights.
Once you have selected your preferred invoice discounting company and signed up with them, they will lead you through the process. This entails establishing a system for payments to you, arranging a trust account for customer payments if necessary, and integrating with your invoicing procedures to ensure prompt payment. In many cases, this can be conveniently managed online, particularly if you are using cloud-based invoicing software.
Examples of Invoice Discounting
If you decide to finance a receivable of Rs. 20,000 with a financial institution, they will provide an upfront payment of up to 80% of the invoice value, which would amount to Rs. 16,000 when you hand over the invoice. Once the customer fulfils the payment obligation on the specified due date, you will then receive the remaining balance of Rs. 4,000 after deducting a nominal fee of approximately Rs. 400 charged by the financial institution. In this particular invoice discounting arrangement, the Rs. 4,000 represents the discount provided.
Who Carries Out Invoice Discounting?
- Lending institution: For granting short-term loans secured by outstanding sale invoices, the lending institution levies a service fee.
- Invoice discounting company: Any business in manufacturing, FMCG, logistics, and pharmaceuticals can use the invoice discounting service. One may obtain funds through this form of loan in exchange for outstanding sales invoices.
Types of Invoice Discounting
- Whole turnover invoice discounting: One may obtain a loan for any invoice produced by the company under this sort of invoice discounting. As a result, money may be raised from the whole turnover.
- Confidential invoice discounting: This kind of discounting assures secrecy so that the firms’ clients and suppliers remain in the dark about the nature of the business partnership.
- Selective invoice discounting: In this invoice discounting, only invoices from specific parties can be collateral to raise money.
To sum up, if your company satisfies the aforementioned viability requirements, invoice discounting is an excellent approach to obtaining capital. Increase sales, create cash via invoice finance, and maintain the efficiency of your operations, working capital, and capital investment activities.
FAQs on Invoice Discounting
What is the difference between factoring and discounting?
Invoice discounting and invoice factoring share similarities. However, their primary distinction lies in the party responsible for pursuing overdue invoice payments. In the case of invoice factoring, the finance provider often takes on the role of collecting payments from the buyer. Conversely, in invoice discounting, it is generally the supplier who retains this responsibility.
Does invoice discounting mean borrowing?
Invoice discounting entails obtaining short-term advances against invoices. Nevertheless, when you discount invoices through any invoice discounting platform, it does not qualify as borrowing. It is because the debtor is making the payment to the creditor rather than involving a borrowing arrangement.
What is the repayment period for invoice discounting?
The tenure represents the credit period established between the seller and the buyer as per the terms of the sale. This duration concludes the invoice credit period’s final day or upon settlement of the invoice value, whichever comes first.