Cash flow can stifle a business’s growth if it prevents re-investment and making further profit. Even worse, cash flow trouble can lead to a business incurring late payment fees as well as prevent necessary planning due to unreliable and late payments from customers.
Invoice discounting allows businesses to access money that wouldn't otherwise be immediately available and helps manage bad debts that can cripple the business’ ability to function successfully.
What is invoice discounting?
Invoice discounting is the process in which a business utilises the service of a finance company or bank to access payments before they would usually become available to them. The discounting service will provide a percentage of the value of an unpaid invoice, for a fee, which will then be made immediately available.
How does invoice discounting work?
Discounters, also known as invoice discounters, essentially buy debts from businesses in order to free up funds for their clients. More than 80% of the value of sold debts will usually be made immediately available, with the remaining percentage collected upon payment of the invoice.
This means, for example, that for every £100 sold to the discounter, around £80-£85 will be available for the business typically within 24 hours.
Companies that have a long-standing relationship with the invoice discounting service may be able to receive a higher percentage of the original value. This will depend on successful past transactions and the degree of trust that has built up over time.
For this service the invoice discounter will charge a fee, which will be agreed beforehand and depend on a variety of factors.
What are the criteria?
As risk is minimal, there are no specific rules regarding those who are able to access invoice discounting services, in fact most companies with an annual turnover exceeding £250,000 will be eligible. Each discounter has their own criteria but most established businesses should be able to access the service.
Invoice discounting vs invoice factoring
There are many similarities between the two practices but the main, and defining, difference lies in the accountability of the collection of the debt.
With invoice factoring, particularly non-recourse factoring, the factor assumes responsibility for the debt. This makes the facility much more complex and expensive, so it is not often available to smaller or new businesses. With discounting, the responsibility falls to the business selling the invoice, meaning that no protection is provided against bad debt.
You should also be aware that if using an invoice factoring service, you are legally required to inform your customers that the payment process has been outsourced. However, this is not the case with discounting services.
What are the benefits of invoice discounting?
There are many benefits available to companies of different sizes and from different sectors. These include:
Improved Cash Flow
Cash flow can be a frustrating problem, especially if you are continually waiting on late payments. Invoice discounting allows businesses quick access to 80-85% of their owed funds, often on the same working day as the invoice is processed.
With quick and easy access to funds, companies can invest in larger quantities of materials and goods, and take advantage of bulk-buying discounts that would otherwise be unavailable to them.
Avoid Late Payment Fines
A major frustration of a sluggish cash flow is the inability to pay your own debts on time. This can lead to late payment fines that add up over time to a considerable amount. Easy access to funds can help a business manage debts more efficiently and avoid these kinds of unnecessary costs.
Continual investment is vital to business growth, so being able to use funds to maximise profit is essential in helping a business reach its potential. All companies need access to capital and discounting services are designed to provide this in an efficient manner that can transform the entire outlook of an ambitious business.
More Effective Planning
If you don’t know when payments will clear, financial planning can be extremely difficult. It can be even more frustrating when the receiving of payments is not in your control. This leads to over-conservative planning or risk taking that can inhibit a company’s ability to function properly.
Discounting can offer you peace of mind, as knowing that the vast majority of your funds will be released as and when they are needed helps you to plan more effectively for the short and long term future.
What are the costs of invoice discounting?
Every discounter charges different rates and fees, all of which will be calculated in a variety of ways and depend on your individual circumstances and the value of invoices you wish to factor. The main costs are:
There are two main service fees and these are charged whilst the service is used. The minimum annual service fee is charged monthly, quarterly, or annually and ranges between 0.2-0.5% of turnover. This fee affords the discounter a guaranteed income in the event of unexpectedly low revenue from the business employing their services.
An administration fee is also charged and is based on the value of the invoices presented. It is sometimes referred to as the credit management fee.
Similar to charges incurred with a bank account, interest or discount charges will be calculated on the funds processed. This will typically be in the range of 1-3% and depends on the specific discounter.
Some invoice discounters may also present other charges related to their particular service. For this reason you should always study the terms and conditions of the service. If you are unsure, you should ask the invoice discounter to provide you with the relevant information.