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Invoice Discounting is a widely used form of short term business commonly used across a wide range of industries such as manufacturing and recruitment.
What is Invoice Discounting
Simply put, invoice discounting is where a business borrows money from a lender who advances the business cash amounts based on their unpaid sales invoices.
How Does an Invoicing Discounting Facility Work
Invoice discounting can seem confusing so here is an example to demonstrate how an invoice discounting facility works.
XYZ Limited sends a customer an invoice for £50,000, with 30 day payment terms. Their invoice discounting lender agrees to advance XYZ Limited 85% of the invoice value while they wait for their customer pays. Here are the steps involved in the invoice discounting process:
XYZ Limited sends their customer an invoice for £50,000 with credit terms of 30 days including the bank details of the invoice discounting lender on the invoice.
XYZ sends a copy of this invoice to their invoice discounting lender along with confirmation of the order to verify the order is real.
The lender advances XYZ 85% of the invoice value immediately, so XYZ receives cash in their bank account of £42,500 less charges.
30 days go by and the customer settles the invoice in total of £50,000, using the invoicing discounting account details shown on the invoice.
The invoice discounting lender has therefore collected 100% of the invoice value, so owes XYZ Limited 15% of the invoice amount since it only advanced 85%. Therefore it sends XYZ the remaining £7,500 (less interest and charges it is owed on the arrangement).
The Benefits of Invoice Discounting
- Great for cashflow: rather than waiting for your customer to pay, with invoice discounting you can access a generous portion of the cash you are owed up front.
- Limited Security: unlike with traditional bank loans and overdrafts where security, assets and collateral are required, with invoice discounting the loan is secured on the invoice raised (although this normally requires a credit check of your customer).
What to Look Out For with Invoice Discounting
As with any form of finance, there are pitfalls that you should watch out for:
- Invoice discounting can be an expensive method finance, with interest and charges at each stage of the cycle.
- If you customers exceed their credit terms and are late settling invoices that you have borrowed money on, you can find the lender may restrict future borrowings until the later paying customer settles their invoice.
Anita is a Chartered Accountant with over a decade of experience taking self employed business owners from financially confused to business savvy.
She is the creator of the ‘Go Self Employed’ website, which her corner on the internet where she makes self employment less terrifying.