What is invoice discounting and can it help company cash flow?

Updated: 5th February 2021

Invoice discounting is a specific form of invoice finance that can help your business cash flow and support growth. It differs from invoice factoring as you remain in control of your sales ledger and debt collection procedures, but it can benefit some businesses more than others.

One of the main eligibility criteria for invoice discounting is a substantial turnover, so this alone could typically rule out start-up and some young businesses. But how does invoice discounting work in practice, and could it be right for your business?

How does invoice discounting work?

You gain immediate access to a high proportion of each pre-agreed invoice issued, typically 80-90% before your clients and/or customers have made payment. The money is credited to your business bank account by the lender, minus their charges and fees.

You continue to collect each debt as normal, repaying the lender when your customers have paid. With invoice discounting you retain control of your debtor book and therefore the responsibility for collecting money owed from clients stays with you. An alternative form of invoice financing, known as invoice factoring, sees you handing over your debtor book to the factoring company who will chase for payments on your behalf.

Confidential invoice discounting is generally favoured by businesses using this funding method. It may cost more than the alternative - disclosed invoice discounting - but it means your customers are less likely to have concerns over your financial stability.

Your turnover will need to be higher for confidential invoice discounting, but there is also another variation on this type of finance that you will need to consider.

Invoice discounting with and without recourse

Invoice discounting with recourse means the lender can claim back their money if you cannot recover a debt from a customer. When an invoice discounter assesses your application for finance they will look at various aspects of your business, including previous bad debt levels, your credit control procedures, and how quickly customers pay on average.

Based on this information they may offer you an invoice discounting agreement with or without recourse, but if you opt for a contract without recourse you will need to pay an additional amount for credit insurance to cover the lender’s increased risk.

How does invoice discounting help business cash flow?

Invoice discounting provides regular injections of working capital throughout each month, so you do not have to worry about paying your own bills. Cash flow shortages commonly occur towards the end of a month when a business has not yet received payment for work done, but still needs to pay wages and other regular outgoings.

It takes very little for cash flow to be completely disrupted under these circumstances – an unexpected bill, for example, or loss of a customer – and the threat of insolvency suddenly looms.

So what are the advantages and potential drawbacks of invoice discounting for businesses?

Advantages of invoice discounting

Potential downsides

  • You will need a minimum level of turnover to be eligible
  • You must have stable credit control procedures and systems
  • Interest rates may be high, but this can sometimes be offset if you have higher-than-average profit margins

It is worth remembering that if you do not meet the criteria for invoice discounting, your business may still benefit from another form of finance such as invoice factoring or a commercial loan. Our partner-led team of insolvency experts at Begbies Traynor can provide the professional advice you need if you are considering invoice discounting. We operate a nationwide network of offices – please call today for a free same-day consultation.

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