An introduction to invoice discounting
What is invoice discounting?
Invoice discounting is a type of lending whereby a business sells its unpaid invoices to a lender in exchange for a cash advance of a percentage of an invoice’s value. Once a customer has paid an invoice in full, the lender will pay the business the remainder, less its fee. In essence, invoice discounting is a series of short-term business loans which use an invoice as a form of security.
Is invoice discounting a good idea?
Cashflow is the lifeblood of any business, large or small, and the ability to pay salaries, settle bills and finance projects can be impacted by the late payment of invoices. In December 2019, Accountancy Age reported that average late payment to SMEs had almost doubled year-on-year from 12 to 23 days, with £34bn owed on late payments, an average of £34,286 per business.
At any level, late payment can be a challenge for a business and one way to overcome this hurdle is using invoice discounting to keep a steady flow of cash coming into the bank.
Invoice discounting is sometimes incorrectly associated with debt collection and perceived to be a last resort for businesses that are challenged with managing cashflow, but this type of finance has evolved hugely in recent years and offers a highly flexible lending facility.
Previously regarded as an ‘all or nothing’ option offered over a lengthy agreement, today invoice discounting agreements can be tailored to suit a business’ requirements. For example, a company might choose to borrow against a limited number of invoices or even a single debt, and agreements can range from 30 days to a year providing a far more flexible facility.
To arrange an invoice discounting facility which suits your business, talk with a commercial finance broker who will help identify a suitable lender. Even if you operate in a sector which is considered to have a higher risk of non-payment, some lenders will provide an invoice discounting facility and reduce its fees over time, once it is comfortable that your invoices are paid regularly.
What are the advantages on invoice discounting?
In addition to providing ready access to funds to develop your business, invoice discounting offers a number of benefits including:
- Enables you to access lending without the need to provide assets as security
- Improves your business’ cashflow
- Grows with your business – as your company increases the volume and value of the invoices it issues, there is greater scope to borrow against this projected revenue without the limitations of secure lending based on fixed assets
- Offers a potentially endless supply of funding, reliant only on your business’ ability to operate and generate invoices for work undertaken
- Is a discreet form of borrowing – unlike invoice factoring, with invoice discounting your customers will be unaware that your are using this type of lending
- Can provide funds quickly once an agreement is finalised with a lender, often within 24 hours of an invoice being raised
- With a facility in place, invoice discounting does not require re-negotiation or incur ongoing arrangement fees, like an overdraft facility
What are the disadvantages of invoice discounting?
There are few disadvantages, but it is important to understand that the invoice discounting agreement may limit the amount and terms of credit you are able to offer clients. If an invoice is disputed, it will be essential to take swift action to ensure the section is rectified so it does not affect the agreement. Inevitably, invoice discounting will affect your day-to-day accounting practices and it will be important to send out invoices promptly as work or orders are delivered.
Will my company benefit from invoice discounting?
To benefit from invoice discounting, a company needs to:
- Be established with a reliable turnover
- Have robust invoicing and credit control procedures
- Have minimal bad debts
- Have customers which pay on time
How much does invoice discounting cost?
With a growing number of lenders willing to provide an invoice discounting facility for businesses, they will typically offer 15-20 per cent of the value of the invoice. For example, if a company invoices £100,000, based on an 85 per cent advance it would offer £85,000 as a cash advance. Once the invoice is paid in full, the lender will release the remaining 15-20 per cent, less its fee.
Why do I need to work with a broker to organise invoice discounting?
An independent commercial finance broker will help you to identify that invoice discounting is the best type of lending for your business. An independent broker will also work with a large number of lenders and be able to find the right match for your business even if you don’t meet the exact criteria, as they may be more flexible than others.
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