Are your company’s trade credit terms affecting its cash flow? Waiting 30 days or more for payment from your customers can affect your company’s financial health and increase the risk of cash flow problems.
If your company offers products or services to its customers on credit, you can use invoice discounting to receive cash as soon as you issue invoices and improve cash flow.
Invoice discounting is a process that involves your company borrowing against its accounts receivable or sales ledger from a discounting company. You’ll still need to collect on the invoices, but you’ll receive an up-front payment to create cash flow.
This cash flow provides a predictable source of income that your company can use to pay its staff, suppliers and other creditors. Cash flow issues, which are common for companies that offer trade credit, are no longer a problem.
Like invoice factoring, which is a similar procedure, invoice discounting is suited to companies that have a long trading history and reliable customers but need help to generate short-term cash flow and avoid insolvency.
Quick facts about invoice discounting
- Invoice discounting involves your company borrowing against the value of its sales ledger. For example, your company might be able to borrow £10,000 on an invoice with a value of £12,500.
- Like with invoice factoring, the invoice discounting company will provide a percentage of the value of each invoice immediately, and the remaining cash upon your receipt of the customer’s payment.
- Your company will pay a fee to the invoice discounting company whenever it borrows money against an invoice. The discounting company will also charge interest on the cash borrowed against the invoice’s balance.
- Because invoice discounting fees are charged on each invoice, discounting is a better solution for companies with few large invoices than companies with a high volume of low-balance invoices.
- Invoice discounting is usually a more flexible option than invoice factoring, as your company may be able to borrow against individual invoices instead of its entire sales ledger.
What is invoice discounting?
Invoice discounting is a cash flow solution that provides your company with instant cash based on the value of its outstanding sales invoices. Discounting companies will usually provide 80% of the value of each invoice in cash as a short-term loan.
The invoice itself is the collateral for the loan, reducing the risk for the discounting company and providing your company with a line of credit against its invoices that otherwise may not be available.
When your company uses invoice discounting, it remains responsible for collecting the balance of each invoice and managing trade credit. Your company will need to provide detailed reporting on its accounts receivable to the discounting company.
Unlike invoice factoring, which is public, invoice discounting is a more discrete way to improve your company’s cash flow. Since your company collects on its invoices, customers will be unaware that you’re using discounting to improve cash flow.
When should your company use invoice discounting?
If your company usually waits 30 or 60 days from the end of each month to receive cash from its customers, it may have difficulties paying its staff, suppliers and other creditors due to limited cash reserves.
Invoice discounting is a convenient, discrete and relatively inexpensive option for companies that need to improve short-term cash flow but don’t want to use a loan or simply can’t access credit from a bank or business lender.
Like invoice factoring, discounting is only a viable cash flow solution for companies that have steady, predictable monthly sales. If your company generates little or no revenue, invoice discounting is unlikely to solve its cash flow problems.
Because invoice discounting companies assess risk based on your customers’ credit, discounting is a viable option for companies that are relatively young and lack the sales history and credit worthiness for a standard bank loan.
Companies typically use invoice discounting to improve cash flow during periods in which slow trade credit affects their access to cash, or to bridge the gap between an invoice’s delivery to a customer and collection of the payment.
Although discounting can be used to avoid insolvency by creating cash flow, it isn’t an effective option for insolvent, unviable companies. Most insolvent companies are better suited to proposing a CVA or entering into administration as solutions.
Unlike invoice factoring, which is public, your company’s customers will not know that you’re using invoice discounting. This is because your company is responsible for managing its trade credit and collecting payments from its customers.
How is invoice discounting different from invoice factoring?
Although invoice discounting and invoice factoring produce a similar outcome – an improvement in short-term cash flow for your business – the two procedures have several differences:
- Invoice factoring is a public process that your company’s customers will be aware of, while invoice discounting is discrete. Customers will be unaware that your company is using invoice discounting to improve its cash flow.
- When your company sells its invoices to a factoring company, it is no longer responsible for collection. When your company uses invoice discounting, it’s still responsible for collecting payments from its customers.
- Invoice discounting is often a more flexible procedure than factoring, as your company may be able to receive cash against only select invoices instead of selling its entire sales ledger to a factoring company.
- Like invoice factoring, invoice discounting is typically only available for B2B companies. However, in some cases, both factoring and discounting services may be available for companies that sell directly to customers.
How much does invoice discounting cost?
When your company borrows against its outstanding invoices, it pays a fee to the discounting company on each transaction. This makes discounting less expensive for companies for companies with a small volume of high-value invoices.
In addition to transaction fees, your company may need to pay interest on the cash that it borrows from the discounting company. This interest rate can vary based on your company’s credit history and the credit worthiness of its customers.
Get expert financial help
Are you concerned about your company’s cash flow? If your company frequently has cash flow issues as a result of its trade credit arrangements with customers, it could use invoice discounting to improve its cash flow and avoid insolvency.
Invoice discounting is a convenient alternative to invoice factoring that offers many of the same advantages without having such a significant effect on your company’s relationship with its customers.
Contact us to speak to a finance expert and learn more about the invoice discounting process. We can provide help and assistance to ensure your company receives the cash it needs to pay its creditors, avoid liquidation and keep