What Is Invoice Discounting?
Invoice discounting is a financial service in which a provider lends cash to a company up to the value of its unpaid invoices.
Many international Suppliers work with deferred invoice payment terms - often up to 120 days - which can put a strain on their finances. Many Suppliers also struggle to qualify for bank loans to ease their cash flow due to having a short or poor credit history.
However, a Supplier can apply for invoice discounting from lenders that will accept unpaid invoices (accounts receivable) as proof of money owed. The lender will advance money to the Supplier and use the invoice(s) as collateral. On the due date, the Buyer settles the invoice and the Supplier returns the borrowed amount to the lender and pays a pre-agreed service fee.
How Does Invoice Discounting Work?
A typical invoice discounting agreement includes the following steps:
- A Supplier sells goods to a Buyer and raises an invoice, often with deferred payment terms of up to 120 days.
- The Supplier needs working capital, so submits the invoice to an invoice discounting provider, presenting it as security for a short-term loan.
- The invoice discounting provider evaluates the invoice and creditworthiness of the Buyer and agrees to advance a percentage (often up to 95%) of the invoice total as a short-term loan.
- The provider charges a pre-agreed fee, typically 1-3% of the loan.
- The Buyer pays the invoice within the agreed 120-day window.
- The Supplier pays back the borrowed amount to the invoice discounting provider, plus the pre-agreed service fee.
Example of Invoice Discounting
ABC Supplier Ltd exports goods worth £10 000 (GBP) to its overseas buyer, XYZ Buyer Ltd, and raises an invoice with 90-day payment terms.
However, ABC Supplier needs immediate working capital to pay its bills so it submits the unpaid invoice to an invoice discounting provider as proof of owed income.
The invoice discounting company agrees to provide ABC Supplier with 95% of the invoice value immediately - totalling £9 500 (GBP) - in exchange for a fee of 2% of the lent amount when the invoice is paid. This fee will amount to £190 (GBP).
XYZ Buyer pays the total £10 000 (GBP) invoice in 90 days and ABC Supplier repays the borrowed sum to the invoice discounting provider, plus the pre-agreed 2% service fee.
The short-term trade financing loan is now paid off, and there are no long-term repayment plans or obligations that could affect ABC Supplier's credit score.
Benefits of Invoice Discounting
Invoice discounting provides plenty of benefits for small- and medium-sized enterprises (SMEs). Some of the key benefits include:
- Easy and fast access to working capital that would otherwise be tied up in unpaid invoices.
- Improved cash flow for Suppliers to pay their own suppliers or invest in the growth of the company.
- Finance approval is based on individual invoices rather than credit history or long-term forecasts, making it more likely that companies are given finance.
- Discounting fees usually never exceed 1-5% of an invoice amount. (N.B. This figure depends on the terms of your facility and can vary between financiers).
- Companies are not subjected to long-term, high-interest repayment agreements.
- The invoice discounting application process is usually much simpler and quicker than applying for a bank loan.
- Invoice discounting is usually confidential, so the Buyer never knows that the Supplier has borrowed from a third party.
Is Invoice Discounting Right for My Business?
Suppliers working regularly with deferred payment terms can benefit from invoice discounting. It might also be a good choice for any Supplier experiencing:
- Rapid growth - Working capital is essential to fund new equipment, facilities and staff to support growth. Invoice discounting allows companies to access cash quickly rather than wait weeks or months for invoice payments.
- Cash flow problems - Invoice discounting frees up working capital to cover business expenses.
- Refusal for loans from banks - Many Suppliers may simply be refused loans from banks due to limited or poor credit history. If a Supplier does get a bank loan, it often comes with long-term repayment plans and high interest rates, which can prove difficult to commit to. Invoice discounting ensures that cash is granted to cover money already owed to the Supplier, with the matter closed as soon as the invoice is paid.
Invoice Discounting FAQs
What is confidential invoice discounting?
Confidential invoice discounting refers to an agreement in which a Buyer is not made aware that the Supplier is using a financing provider. This is good for Suppliers that want to maintain existing relationships with Buyers without drawing attention to their use of a third-party lender.
The downside to confidential invoice financing is that the Supplier remains solely responsible for chasing Buyers for late payments. In other financial agreements, such as non-recourse invoice factoring, the financing provider often assumes responsibility for chasing the Buyer for payment.
What is selective invoice discounting?
Selective invoice discounting means that a Supplier selects specific invoices to submit for finance, rather than financing its entire accounts receivable ledger.
Selective invoice discounting allows a Supplier to access the working capital it needs at any time. Selective discounting also keeps fees to a minimum.
What is the difference between factoring and discounting?
Invoice discounting and invoice factoring are similar but the main difference is who is responsible for chasing late invoice payments.
With invoice factoring, the finance provider often assumes responsibility for collecting from the Buyer. With invoice discounting, the Supplier typically retains this responsibility.
If you are interested in learning more about the content listed above, Stenn has a dedicated FAQ section where you can find more information about our invoice financing services. We also provide videos which explain the company and the financing process in detail.
About the Authors
This article is authored by the Stenn research team and is part of our educational series.
Stenn is the largest and fastest-growing online platform for financing small and medium-sized businesses engaged in international trade. It is based in London, provides financing services in 74 countries and is backed by financial giants like HSBC, Barclays, Natixis and many others.
Stenn provides liquid cash to SMEs within the global financial system. On stenn.com you can apply online for financing and trade credit protection from $10 000 to $10 million (USD). Only two documents are required. No collateral is needed and funds are transferred within 48 hours of approval.
Check the financing limit available on your deal or go straight to Stenn's easy online application form.
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