Friday 5th Jun 2020
When it comes to business finance, the market offers a wide range of products, each specially tailored to particular situations and types of businesses. While loans and overdrafts are commonly recognised, there are of course other alternatives. Invoice finance is one of the categories, and invoice discounting is a particular product of this potentially useful funding option. In this article, we’ll take a brief look at how it works.
How does invoice discounting work?
First, it helps to understand why a business might choose invoice finance. And the reason is primarily about cash flow. Any good business owner or finance officer will understand that cash flow is the lifeblood of enterprises both small and large. With poor cash flow, it can be difficult to meet monthly commitments such as payroll, and nearly impossible to expand or invest in the business. Often, poor cash flow is the result of value being tied up in unpaid invoices, and invoice finance seeks to remedy this.
What’s the invoice discounting process?
Invoice discounting works differently to your typical loan or overdraft, but such a facility is actually very straightforward. Here’s how invoice discounting works:
First, you’ll agree an invoice discounting facility with a finance provider. This will include costs, rates and limits. Often, limits simply scale with your turnover, so many businesses will be able to have a facility running for several years without needing any kind of lengthy renegotiation process.
From then on, when you raise an invoice, you’ll also send a copy to your finance provider, who will pay you up to around 80-90% of the value of the invoice straight away - usually within a day or so.
Your customer will pay the invoice, generally into an account held jointly between you and your finance provider.
On payment of the invoice, the remainder of the invoice value is transferred to you, less any fees such as interest.
The process simply repeats for any invoices that you raise, whether they’re for goods or services, and however long the due date might be.
Invoice discounting is kept completely confidential
which means there’s often only a small process change for businesses that choose to use it. It’s a relatively easy way of releasing cash instantly, to be used as needed. There are of course costs associated with using a discounting facility, and these must be weighed up against the benefits of having swift access to the cash that’s owed to the business. It’s always worth seeking independent advice to ensure that discounting is the right product for your circumstances - a more traditional product will be suitable in some circumstances, and if you need credit control assistance for example, then factoring could be a more effective choice.