Invoice Discounting and How does it work?
It requires finance to manage a business. Business finance has been evolving until the present times when alternative finance, trade finance and the approach of fintech has brought new opportunities for SMEs to progress and grow their businesses. Business finance includes other areas as Invoice financing and factoring.
The history of invoice finance is demanding for businesses and is divided into two sections: Invoice discounting and factoring. Invoice discounting is one of the common ways to borrow finances, which is required to avoid the delay of working capital required for the day-to-day operation of a business.
Invoice discounting is an approach of debtor finance. It aids companies that have cash flow problems as the customer pays the invoices in 30 or 90 days.
So, invoice discounting is an asset-based finance facility, wherein the businesses leverage their account receivables to gain a loan against these receivables from a third -party financial institution.
Hence, invoice discounting is a method enforced for using business owners’ due account receivables as collateral for loans. This outstanding receivable is being distributed by finance companies. This method of financing and discounting is a short-term appeal of borrowing finances required for the day to day working of a business. And it comes with a reason, where the finance or the distributing company can revise the value of debt unresolved.
Usually, the amount of debt granted by the finance company is substantially lower than the amount of outstanding receivables. Usually, this is 80% of the amount for invoices that are less than the term of 90 days old. Permitting the customers to make the payment in 30 to 90 days can affect a company’s cash flow if the financial reserves or accumulation are not ample enough to pay for corporate expenses. This situation occurs frequently with growing businesses when an owner tries to turn around the company or if the business is progressing at a quick pace. Therefore, Invoice Discounting helps a company to boost its cash flow and settles a company for future progress.
How Does It Work?
Let’s say a company sends out invoices on a daily basis as and when the task gets completed or when an order is fulfilled. Post that, for every pre-agreed percentage on each invoice, the amount is credited in the company’s bank account after the lender has received the invoice copy. Hence, the money received can be utilized for the day-to-day operations of the business. Like paying the bills, repaying debt, and can also for meeting some long-term financial goals.
Below is the step-by-step process of how Invoice Discounting takes place:
1 The task of running the business and invoicing the clients/customer remains the same.
2 Post that, the required invoice information is forwarded to the financial institution, who is the finance provider for the invoice.
3 The finance provider pays the company upon an agreed percentage, which differs from one company to another.
4 As per the accord, the company would chase the payment as they have been doing it or the provider could take the initiative.
5 Finally, the company receives the remaining of the invoice amount once the invoice is paid, after making the necessary deduction on agreed charges or fees.
Benefits of Invoice Discounting
- Termed as a quick fix to traditional methods of finance.
- Offers an instant approach to cash, which is tied up in outstanding invoices.
- It is a confidential method of financing while having control over the collection of payments.
- A fast funding method of financing and also involves less paperwork. Hence, it saves time.
- It accustoms to the changes in the market and business and hence is a flexible way of financing than overdraft or loan.
Therefore, Invoice Discounting speeds up the cash movement from customers wherein the agenda is not to wait for clients to make payments within their credit period. It is an essential source of working capital finance due to the constraints of bank financing because of the creditworthiness at stake. Invoice Discounting is more appealing to a bank as it depends on the invoice’s unpaid security from the debtor.
Invoice discounting is a practice, which substantially uses the company’s due accounts. And if done well, it could aid the business owner’s in supervising the cash flow adequately.