Invoice discounting

Invoice discounting is the process of taking out a business loan that's secured against your business' outstanding invoices. The amount available will be a proportion of these outstanding invoices (often up to 80%) and will therefore fluctuate over time as invoices are settled and new ones issued. The general aim is to improve your business' cash-flow. Your customers continue to deal directly with your business (in contrast to invoice factoring). The lender charges both a fee and interest on the amount borrowed.

The details

Invoice discounting involves entering into an agreement with a finance company under which they agree to make a variable-sized loan available to your business using its outstanding invoices as collateral. The agreement usually covers all invoices and operates as follows:

• Your business issues an invoice to your customer as usual.
• Your business informs the lender who increase the maximum amount you can borrow (usually by up to 80% of the new invoice value).
• The business can choose whether or not to draw down this amount.
• When your customer settles the invoice, you inform the lender and they decrease your maximum borrowing accordingly. 

Fees usually include a monthly management fee plus interest on the amount borrowed.

If your customer fails to pay then there's a question over who is liable. This depends on the detail of the discounting agreement. If it's a "recourse" agreement then your business is still liable to pay back to the lender the money they advanced – and may still be liable for the fees, too. On the other hand, if it's a "non-recourse" agreement then the lender absorbs the loss – your business doesn't have to repay the advanced money, although again it may still be liable for fees. "Non-recourse" discounting arrangements have additional fees and/or higher interest rates to cover this risk.

Who provides invoice discounting services?

Invoice discounters are usually specialist independent finance providers or part of the major banking groups.

Who is invoice factoring suitable for?

Businesses who issue invoices with payments to be made by a future date (so it's not usually suitable for businesses who deal in only cash or debit/credit cards where cash advances may be more suitable).

Advantages

• Invoice discounting can provide an excellent boost to cash-flow / working capital
• Your business retains control of issuing invoices and dealing with customers
• Flexible form of financing – your business decides how much (or little) to draw down at any time

Disadvantages

• Fees imposed by the lender will reduce your profits
• Discounting arrangements can be hard to terminate
• Discounting can be disclosable to your customers (although usually isn't) – some of them may not look upon it favourably