Invoice Discounting

Invoice discounting refers to the process in which any business sells invoices to a third-party company, also known as a financing company.

Immediately after selling the invoice, the business receives a percentage of the total amount billed to the client. On the other hand, the finance company acquires the responsibility of cashing the complete payment from the purchaser.

One of the main reasons why companies sell their invoices is to get access to cash, which facilitates enhancing their cash flow and working capital cycle.

Businesses that do not wish to or cannot afford for clients to pay their bills often follow this popular method of financing. As opposed to other ways of finance such as loans, FDs or overdrafts, invoice discounting is deemed an effective alternative method.

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Why is Invoice Finance needed?

Invoice finance facilitates businesses to improve their cash flow and pay salaries to their employees and others members of the supply chain. Moreover, the popular finance method also helps businesses to reinvest in operations and growth-related opportunities that otherwise would have only been possible after the clients cleared their payments in full.

Types of Invoice Finance

Here are three of the main variants of invoice finance:

Confidential invoice discounting

As the name suggests, confidential invoice discounting refers to a variant of invoice financing that companies can arrange secretly. It ensures that both the customers and the suppliers remain unaware that the business is advancing positively. In this type of confidential invoice discounting, capital against the sales invoice is received before the payment is made.

Invoice discounting funding limits

When it comes to invoice discounting, the majority of the companies do not take into account the business’ individual debtors, which take the help of invoice discounting. However, they protect themselves against the debtors‘ insolvency by being dependent upon the business, which boasts of a broad base of customers. Moreover, they ask for a certain percentage of the business’ sales ledger that a specific customer makes up.

Whole turnover invoice discounting

As opposed to selective invoice discounting, single receivables are purchased by a third-party entity for every invoice in the whole turnover invoice discounting variant of invoice discounting. Moreover, the company’s entire sales ledger is required to flow through the factor.

The differences between Invoice Discounting and Invoice Factoring

Both invoice discounting and invoice factoring offers firms and organisations an advance for unpaid invoices. However, they have numerous differences. For starters, invoice discounting is a loan. On the other hand, an invoice factoring company purchases a firm’s unpaid invoices at a discounted rate.

When it comes to invoice discounting, the customer does not know that the invoice has been discounted, whereas, in the case of invoice factoring, the customer is fully aware that the invoice is being factored.

Another significant difference between invoice discounting and invoice factoring is that in the former’s case, the business is responsible for collecting invoices. In the latter’s case, the finance company is the party that holds the responsibility of collecting invoices.

Invoice Bill Discounting

Invoice bill discounting is a trading activity wherein a seller sells their products or services to another entity. The trader selling their goods or services is required to complete the payment in accordance with the agreed-upon credit period.

If the purchaser requires funds before the credit period, they can approach a bank or NBFC and sell the invoice in question to them. The finance company then verifies the invoice by the purchaser and makes the payment to the seller in their place. However, the entity making the payment deducts some portion of the amount, known as discount. The discount acts as their commission for the whole transaction.

How does Invoice Discounting work?

Invoice discounting works in the following way:

  •  A business sells its goods or services to a client.
  • The business selling the good or providing the service shares an invoice with the client and gives them a deadline of up to three months to pay.
  • After this, the business then forwards the invoice to a third-party entity, which in most cases, is a finance company.
  • The finance company to which the invoice is forwarded purchases the accounts receivable from the firm or business.
  • When the customer pays back, the invoice’s balance is dispatched back to the business. However, a certain amount of service fee is subtracted from the remitted balance.

Features of Invoice Discounting

Here are some of the most prominent features of invoice discounting:

  • Invoice discounting facilitates businesses to raise funds quickly instead of cleared invoice values before their due dates arrive.
  • Some invoice discounting loans include a processing charge which may range from 0.20% to 0.50% of the total turnover.
  • Interest rates on invoice discounting loans generally vary between 1.5% to 3% above the generic market rates.
  • Even though invoice discounting often reduces profits in the short run, they offer businesses the opportunity to offset the losses incurred by establishing newer and better business opportunities.

Benefits of Invoice Discounting

Here are some of the benefits that invoice discounting offers:

  • Invoice discounting facilitates businesses to enhance their cash flow.
  • Any business, irrespective of whether they own any high-valued assets or not, can acquire funds. Moreover, acquiring invoice discounting loans does not require pledging any collateral.
  • Invoice discounting loans are available for both major and minor businesses which may not have been able to acquire funding from traditional finance companies in the past.
  • The financial institution offering invoice discounting adheres to the company’s needs and requirements and thus offers a flexible financial solution.

Industries Benefitted by Invoice Discounting

Here are some of the most common industries which invoice discounting caters to and benefits:

Manufacturing Industries

Manufacturing industries always have numerous financial requirements. For instance, there are numerous instances when the pieces of machinery need repairs or maintenance, both of which require funds. Besides this, manufacturing industries also have employees on a regular payment basis and numerous similar overhead expenditures. Hence, manufacturing companies utilise invoice discounting to resolve cash flow-related concerns.

Printing & Publishing Industries

With the help of invoice discounting, printing and publishing industries grow and develop conveniently. Thanks to the aid of invoice discounting, printing and publishing companies are not required to wait for more extended periods to receive payments from clients. This, in turn, facilitates businesses to take on new contracts or repair machinery quickly.

Construction Industries

In the construction industry, payments are generally delayed. This cash flow problem disrupts the business’ growth and flow. With the help of invoice discounting, construction firms acquire the freedom of bidding on future projects with confidence and compete strongly against other companies whenever required.

Small Business Invoice Loans

Invoice loans for small businesses provide newly-established or minor companies a revolving credit line against invoices that have not been cleared yet. Moreover, it does not have a negative impact on the firm’s relationship with its client.

Instead of selling non-cleared invoices to a factoring organisation and incurring the discount associated with it, invoice financing or loans enables businesses to retrieve control over all their invoices.

Features of Loan Against Invoice in India

Here are some of the main features of loan against invoice India:

  • Loan against invoice facilitates newly-established small businesses to acquire funds instantly based on the invoices that are already present and available as collateral.
  • Bill discounting is deemed an invoice business loan.
  • Firms can sell the invoice at up to 90% of its overall value to the discounting agency and obtain funds in cash.

When to Use Invoice Discounting

Invoice discounting performs exceptionally well when it comes to companies that have a relatively higher margin of profit. It is because they have the option to absorb higher interest charges which are generally associated with this sort of financing.

Invoice discounting is immensely popular and common in high-profit-yielding businesses, which are exponentially experiencing growth and therefore require cash flow to add to their rising growth.

Taking the help of invoice discounting is not possible when another lender holds the blanket title to all of the company’s assets as collateral on another loan. If and when this happens, the other lender is required to let go of its rights to the multiple accounts’ receivable collateral. Instead, they must take a lower position behind the finance-based company.

Invoice Discounting – How Does It Help

There are numerous ways in which invoice discounting helps businesses. Here are some of the most prominent ones:

  • Using invoice discounting facilitates companies to quickly access funds, which in turn enhances their cash flow.
  • Numerous financial companies offer invoice discounting to companies in a hassle-free manner. The complications-less procedure of accessing funds facilitates companies in fulfilling urgent financial needs.
  • It does not involve any hidden fees, which adds to the transparency of the fund-acquiring method.

FAQs

The facility of acquiring funds from invoice discounting is available to all businesses or firms selling goods or providing services to clients. The credit period for invoice discounting ranges between 1 month and 3 months. The key players in invoice discounting include manufacturers, distributors, B2B services, etc.

Invoice financing is the process of borrowing funds against outstanding receivables of an account. In invoice financing, a lender provides a firm money upfront, as a loan or credit.

Invoice factoring refers to selling outstanding invoices to a factoring company at a reduced price or discount. The company pays the customer a percentage of their invoice upfront, following which they assume the responsibility for.

No, invoice discounting does not require the customer to pledge any collateral to acquire a loan. The customer’s debtors or their accounts receivable ledger for which they seek the loan act as the collateral.

Some of the main benefits of invoice discounting are:

  • Access funds quickly and conveniently.
  • Avoid the hassle of chasing invoice payments from clients.
  • Protect yourselves from bad debts.

The loan amount sanctioned for any user depends entirely on their financial requirements, needs, credit assessment, and numerous other factors. Depending on the factor, financial companies can grant loans of up to 90% of the total value of the invoice as per the customer’s conditions.