Invoice Discounting

Invoice discounting is a type of borrowing that is used to quickly help a company’s cash position. Discounting allows a business to receive money against open customer invoices prior to the customer actually paying the invoice. This is basically a short term boost for the businesses working capital.

In order to discount its invoices the business must work with a finance company. The business will receive cash from the finance company in exchange for effectively using its unpaid invoices as collateral. The business can borrow from the finance company an amount up to generally 80% of the unpaid sales invoices. As customers pay off invoices and new sales invoices are generated the amount available to the business from the finance company will change so that the amount available to be advanced remains at the agreed upon percentage of outstanding sales invoices. The finance company will charge interested on the amount borrowed and generally a month fee. The business will pay interest only the actual amount of money borrowed from the finance company.

Realize that this discounting method is a little bit different than invoices factoring. With factoring your company is actually selling its accounts receivables to a third party. It isn't using the invoices as collateral, but as inventory. Usually in a factoring situation, the third party financing institution will be the one that ultimately collects from the customers. This obviously has its pros and its cons. If you want to find out more about this method then you can read up on factoring with recourse.

In order to protect its interests the finance company will also have the option to refuse lending against some invoices if it believes the customer is a credit risk. In many instances the finance company will not allow lending against amounts due from companies located in foreign countries. Invoices that are for small amounts are usually excluded because the cost of collecting such small invoices is usually not worth the cost for the finance company if it were forced to try to recover the payment. On invoices that have long payment terms the finance company may also refuse to allow the business to borrow against those invoices due to the increased collection risk and long delay before the business’s customer may be required to pay off the invoice.

The customers of the business will usually have no idea that their invoice has been discounted with a finance company. The original business that sent the customer the invoice remains the party responsible for collecting the payment from the customer. The finance company will require regular reports from the business regarding its open sales invoices and the credit control procedures in place at the business.

In some industries a company that is discounting its invoices will be viewed as being in serve financial trouble. As a result suppliers may become reluctant to offer open credit to the money, effectively eliminating much of the benefit of discounting. Customers of the business may also being seeking other suppliers for fear the company may be going out of business.