Smooth cash flow and substantial working capital are essential to keep any business afloat. However, that’s easier said than done. Uncertain market conditions can substantially affect sales turnovers, and lengthy invoicing cycles can impede cash flow, disrupt major plans & investments, and even stall daily operations.
Invoice discounting effectively allows businesses to streamline their cash flow and maintain a healthy working capital. However, any business needs to learn about its nuances, benefits and drawbacks before using the instrument.
What is Invoice Discounting?
Invoice discounting offers a prominent way to keep your business’s cash flow running smoothly and maintain a healthy working capital. Also known as invoice financing involves using outstanding invoices as collateral for getting short-term loans from a financial institution that offers an invoice discounting facility.
The advantages of invoice discounting are immensely significant for any business.
Advantages of Invoice Discounting
Offered by all prominent credit institutions such as banks & NBFCs, and supply chain financing companies, invoice discounting or invoice financing provides numerous benefits.
Here’s a look at the most prominent ones among them all.
1. Quick Cash
Invoice discounting companies offer fast cash through invoice discounting and invoice factoring. The invoice discounting method is more rapid than generic business loans and allows faster disbursal of short-term funds using unpaid invoices as security. In addition, sales receivables allow for a quick infusion of cash to meet working capital needs and carry out significant undertakings.
2. Increased Cash Flow
Availing of the money stuck in transit is much faster than opting for business loans such as term loans or secured business loans. The processes followed by an invoice discounting company are quick and streamlined, designed specifically for raising fast cash to boost cash flow, improve working capital, and keep businesses up & running.
3. Release Locked Cash
Invoice discounting unlocks the cash stuck in the supply chain of a business. An invoice finance provider lends money based on valid customer invoices, turning accounts receivable into fast cash.
4. Use Cash for any Purpose
From improving cash flow & maintaining a proper working capital cycle to carrying out significant expenses and investments, invoice financing offers an easily accessible and flexible business finance option that allows businesses to avail quick cash for different purposes.
5. No Collateral
Invoice discounting does not require any significant collateral or guarantor of any kind. Companies do not need to pledge any real estate, inventory, machinery, or the like. They need only commercial invoices ready to avail of quick business loans from discounting companies and credit institutions.
6. Complete Control
Unlike invoice factoring, invoice discounting companies do not take control of a business’s sales ledger and go about collecting payments for the accounts receivables. Instead, things remain tightly under wraps, allowing businesses to keep their activities privy from their clients.
7. Grow Credit Sales
Among the most prominent invoice discounting advantages is the growth of credit sales. The easy availability of such quick financing options makes companies confident enough to conduct businesses on credit, albeit with trusted partners and customers who meet their payment obligations diligently. Invoice discounting converts said credit into liquid cash, accelerating business processes and fuelling further growth.
8. Faster Payments
Invoice discounting eases cash flow disruptions and allows businesses to meet repayment obligations faster. A good cash flow can also make companies eligible for different loan schemes.
A business’s clients and customers will never find out about the business availing of bill discounting. This is because a reputed invoice finance provider keeps things under wraps and does not take ownership of the sales invoices in a bid to recover all account receivables.
Disadvantages of Invoice Discounting
Like almost everything under the Sun, invoice financing, too, has its drawbacks. The following are some prominent disadvantages of invoice discounting.
1. Decreases Profits
Invoice discounting service providers often charge hefty commissions for their services. As a result, the discount, service, and processing fee can become substantial and affect profits.
2. Industry Sentiment
Making too many credit sales and then getting loans based on invoice value is considered a bad practice and may be looked down upon by clients & suppliers. If you borrow credit based on customer invoices frequently, you should pay close attention to your payment cycles, cash flow, turnovers, and working capital.
3. Borrowing on Commercial Invoices
Invoice discounting is an unsecured business loan, and discounting companies will only provide financing for valid commercial invoices with wholesale dealers, suppliers, and vendors. This can become a problem for companies that deal with the general public.
The volatility of invoice financing stems from the fact that a business can only avail of short-term finance based on the outstanding amounts of sales invoices. As a result, such finances may dry up quickly and are insufficient to carry out any big monetary transactions.
Timely payments from clients and buyers are critical for effectively utilising invoice discounting. However, things can become volatile if clients fail to make timely payments or default.
Invoice Discounting Process
Here’s how invoice discounting works.
- A business sells goods to a buyer on credit. The company can be a vendor, manufacturer, or distributor.
- The business and its clients agree to specific payment terms, wherein the client, that is, the buyer, agrees to pay the invoice amount within a set amount of days.
- To offset the inevitable delay in payment, the business or the supplier can avail of invoice discounting from a financial institution that offers the facility.
- The lending institution reviews the invoices to be discounted and then disburses a certain percentage (generally 80%) of the outstanding amount within a few days.
- The discounting fee is the difference between the invoice and the loaned amount.
- Once all accounts receivables are cleared, the business settles the lender’s debt, who then releases the remaining amount.
Analysing the Viability of Invoice Discounting
Invoice discounting does offer myriad benefits but is only viable and feasible for some businesses.
- Invoice financing suits businesses with an established reputation and high sales turnover.
- Start-ups with limited outreach and substantial uncertainty in sales & revenue may be unable to avail of invoice financing as lenders may need help finding their business operations and reliable enough.
- Companies must have a robust credit control process and clear-cut procedures regarding invoice management and monitoring accounts receivable.
- Payment terms must come with at least 30 days grace period.
- The business must have a good credit history and a history of timely collection of all outstanding payments.
Invoice discounting is a great way to raise funds if your business meets the above viability criteria. Boost sales, generate cash with invoice financing & keep your working capital, operations, & capital investment activities running smoothly.
Is investing in invoice discounting good?
Investing in invoice discounting companies with high credit ratings and a prominent clientele is a great way to diversify one’s portfolio.
Is invoice discounting safe?
Yes, it is safe for investors and buyers if a reputed service provider avails of it. However, despite everything, there’s always the odd chance of a payment default which may out the repayment recourse on the business or the lender.
What is the repayment period?
The repayment or credit period is when the client must clear all outstanding invoice payments.
How is the interest calculated?
Interest rates offered by major invoice discounting service providers are low and range from 1.5% to 3.0 %.