Running a business isn’t always straightforward, especially if it’s a small or medium-sized company that relies on regular cash flow. In this case, outstanding invoices can be a burden that can cause inefficiencies at best and threaten the business at worst. So, instead of contacting your client and putting them under pressure, why not try invoice discounting?
But what is invoice discounting, and how does it work?
Essentially, it helps your business access working capital by selling unpaid invoices to a lender, who provides your company with a loan in return.
An invoice discounting company pays up to 90% of the invoice to your business in cash, giving your clients more time to arrange their payments. Then, once the client has settled the remaining balance, the company pays the invoice minus expenses. Invoice discounting isn’t new, but it has grown in popularity in recent years as it helps small companies balance the sales ledger and stay in business.
So how does invoice discounting work? Read on to find out everything you need to know!
Invoice Discounting Explained
If your business regularly issues invoices that remain unpaid for long stretches, it can cause cash flow problems and affect the performance and credibility of the company.
For this reason, invoice discounting and invoice factoring services exist that can help a business obtain the invoice credit more quickly and achieve credit control. In addition, an invoice discounting service has the added benefit of retaining customer control.
So what is invoice discounting?
Invoice discounting is the process of issuing an invoice to a finance company instead of pursuing a client for the money; the finance solution pays a significant amount of the invoice on behalf of the client – up to 90% – which frees up cash for your company.
After the client pays, the other 10% is returned to your company minus fees for the service. Invoice discounting offers a win-win service for all parties.
Invoice discounting is slightly different from invoice factoring. With invoice factoring, your company sells the invoice to the finance solution meaning the finance provider has complete control of the invoice and the client.
The company retains the client with invoice discounting, so there is no risk of third parties contacting clients to pursue them in ways that might harm your company’s reputation.
When Is Invoice Discounting Right For Your Business?
When running a business, you have responsibilities to clients, employees, and finance companies. For this reason, you need to be careful about taking on finance solutions such as loans and factoring.
So what can you look out for in your business to indicate that an invoice discounting facility is a sensible option? Use our checklist below as a helpful guide.
You have a few bad debts
Smaller businesses often require loan agreements to keep them liquid while they grow. But, for this reason, it’s easy to get into some debt in the beginning, with late payments causing further harm.
While some debt is reasonable for small and medium-sized businesses, it can affect your credit rating and influence the size of bank loans and fees your company can obtain. So if you have unpaid invoices, it makes sense to use an invoice finance facility to free up cash and pay off debts that could be holding you back.
Your customers tend to pay on time
An invoice discounting service can only be successful if your customers pay the balance. If they refuse to pay, it will be up to the company to chase the customer for payment. If a customer cannot fulfil the terms of the agreement, it can end up as bad debt.
However, if your customers and clients tend to pay on time, it bodes well for a successful invoice discounting process. Not only will the finance solution be more willing to lend to you, but it means you can rely on an end payment that helps to balance your books and keep your finances consistent.
You surpass the minimum turnover
The annual turnover of your business is a strong measure of your company’s overall performance, and lenders widely use it to determine your suitability for invoice discounting and loans. Therefore, if your company has surpassed its minimum turnover for the year, there’s a good chance you will be eligible.
The more reassurance you can offer to the lender about your company and customers, the more likely they will be to provide you with an invoice discounting facility. That said, if you don’t have the requirements for the service, negotiation is possible – you can then build confidence through repeat business.
You have good credit control processes
Lenders operate based on risk, so the better your credit management processes, the more chance you have of obtaining invoice discounting services. In addition, since lenders pay the majority of the invoice upfront, any additional reassurance you can offer on the value of the investment is beneficial.
A strong credit control process means having a clear idea of which invoices are paid and which are overdue. It’s also a good idea to organise your invoices in terms of value – which ones are the farthest overdue and which ones have the highest cost. Lenders tend to be responsive to organised systems.
The Different Types Of Invoice Discounting
Invoice discounting refers to the process of using your unpaid invoices as collateral for collecting payments. These cash payments are similar to a loan but have different terms.
For example, a company retains the customer, and when the bill is paid, the company receives the rest of the money from the vendor minus an agreed-upon fee. In recent years this system has grown popular for smaller companies.
Selective invoice discounting
This is very similar to the above – an unpaid invoice is sold to an invoice finance facility which will pay out a percentage of the invoice amount within 24-48 hours. With this option, factoring facilities will generally pay around 70% of the invoice total to the business.
Invoice factoring involves the financing company taking over the business’s credit control and sales ledger for a pre-agreed period. The credit controller will release funds to the business of around 70% of the invoice total when payment is made.
The main difference between invoice discounting and spot factoring is that discounting allows the company to retain relations with the customer, while factoring buys the invoice from the company and deals with the customer directly. In this case, the factoring company is now responsible for chasing up customers directly if payments are missed.
Invoice Discounting Advantages
Your business keeps complete control of its customers with confidential invoice discounting companies. Although your business sells invoices to a third party, customers don’t need to be made aware of this process, called confidential invoice discounting. What’s more, your business is still responsible for chasing up any overdue invoices.
Get paid quickly
When you research your business cash flow options, you will probably encounter bank loans. However, they are more difficult to obtain and take much longer to organise.
On the other hand, invoice discounting is simple to set up, and you can get paid more quickly, sometimes within 24 hours. It is also easier to get approved for an invoice discount than it is for a bank loan.
Cheaper than a bank loan
Bank loans take time to set up; in some cases, it takes around six months to be approved for a business loan. This increases the administration costs, which are reflected in the fees. However, since invoice finance is faster, it is also cheaper overall – worth considering if you need fast cash. Although the invoice discounting company charges an agreed fee, this is more or less the same as interest paid on a loan.
More predictable revenue stream
When it comes to running a successful business, it pays to have a predictable revenue stream; that’s because banks and financial lenders trust companies with consistent incomes, and it makes your tax responsibilities easier to handle.
The trouble is that most businesses can’t predict their incomes consistently unless they use an invoice discounting company to balance the company sales ledger.
What’s The Difference Between Invoice Factoring And Invoice Discounting?
On the surface, invoice factoring and invoice discounting seem to perform the same function and achieve the same aims. Both procedures are ways of obtaining an advance against unpaid invoices; however, there are some important differences when you dig a little deeper.
The main difference is that factoring involves buying the invoice while discounting offers a business loan based on the invoice.
It might seem incidental, but this is a significant difference. When your business retains the invoice, you also retain the confidentiality of the payment, and you have the autonomy to deal with your client.
On the other hand, when you sell the invoice to a factoring company, you break ties with the customer; the factor can then choose to take drastic action against the customer that can affect your reputation.
Is invoice discounting a good idea?
An invoice discounting company is useful for small to medium-sized businesses with some cash flow issues. Invoice finance allows you to bring in money from unpaid work into your company sooner; when your client’s customer pays for the work, you receive the rest minus a fee paid to the lender.
Invoice discounting is usually seen as a company loan, but in truth, it’s safer and cheaper than most business loans. Invoice finance is undoubtedly a good idea if you have unpaid invoices and require working capital.
Who provides invoice discounting?
In recent years invoice discounting services have grown in popularity; for that reason, it can be hard to find the best confidential invoice discounting companies on the high street. However, there’s good news. Quality invoice finance services are easy to find if you need to offload unpaid invoices and bring in cash.
Some of the best companies in the UK for invoice discounting include Bibby Financial Services, Hitachi Capital, and Market Finance. These companies provide accredited financial services, including invoice finance. That said, they are not the only companies available, so try to shop around for the best deals.
Can invoice factoring also be confidential?
Invoice discounting allows you to receive cash for customer invoices without your clients being alerted to your credit management processes, protecting your business’s integrity.
That is not the case with invoice factoring. When you factor your invoices, it is not always confidential, meaning that clients can obtain information on your credit management processes. However, some companies, such as Swoop UK, offer confidential invoice factoring services.
How much does invoice discounting usually cost?
Invoice finance products vary in cost depending on the services required and the company you choose. However, the fees are generally quite low with an invoice discounting service, ranging from 0.2 – 0.5%.