The term invoice discounting refers to a specific form of short-term borrowing that is often favoured by companies that are looking to make an improvement to their cash flow and working capital.
With invoice discounting, a business is able to bring in money against its sales invoices before those invoices have actually been paid by the customer in debt to the company. In order to do this, the business will borrow a specific percentage of the value of its current sales ledger from separate invoice finance companies. This then means that they are effectively using their unpaid invoices as a form of collateral for their borrowing needs.
The end result of invoice discounting is very similar to debt factoring, the only difference being that the business will get the cash they require from sales invoices a bit earlier. This is due to the arrangement process being slightly different.
Features of invoice discounting
When an agreement for invoice discounting is made between a business and a finance company, the latter will usually allow the former to draw down a designated percentage of the currently outstanding sales invoices. This percentage will usually be in the region of 80%.
As the customers begin to pay the outstanding invoices and new sales invoices start to come in, the amount that had originally been advanced will change. Regardless of these fluctuations, the maximum drawdown will remain at around 80% of the sales ledger.
A monthly fee will be charged by the finance company for the invoice discounting services and interest will be charged on the amount that has been borrowed against sales invoices.
Benefits
- The working capital position and the cash flow of your business will improve, you will be receiving cash as soon as a new sales invoice has been raised.
- Invoice discounting is more flexible then using debt factoring companies as your business only has to pay interest on the funds that it has borrowed much like a bank overdraft.
- Some companies provide confidential invoice discounting, so that both suppliers and customers remain unaware that the business is borrowing against their sales invoices before they have received payment.
Drawbacks
- In some industries, debt factoring and the financing of debts is perceived to suggest that the company is in financial trouble. As a result of this, some suppliers may be reluctant to offer credit terms, which may in turn reverse many of the original benefits of the invoice discounting arrangement.
- Compared to a bank overdraft, invoice discounting is a fairly expensive business finance solution.
- Taking out other loans may become more difficult and expensive for the business, as the invoice discounting company legally takes charge of the sales ledger. This means that your business will have fewer assets to present as a form of collateral.
- Once an invoice discounting arrangement has been made, it can be very difficult to leave as your business may invariably become reliant on the new and improved cash flow provided by your invoice discounting.
It is important to find an appropriate company for your invoice discounting, so make sure to compare your options by getting free quotes via Companeo.
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