One major issue facing companies is the delay that often occurs between the completion of a sale and the receipt of payment. Companies sometimes experience serious cash flow problems as a result.
With invoice discounting, the company can borrow a percentage of the amount due as soon as the invoice is issued.
Being able to borrow around 80% of the amount due is common, and on limited occasions a company may be able to borrow a higher percentage. The unpaid invoice is used as collateral for the loan.
On receipt of payment, the balance of the invoice amount, less the lender’s fees and interest, is paid to your company. The Royal Bank of Scotland website describes invoice discounting as: “effectively borrowing your own money.”
Invoice discounting is only available where goods and services are supplied by one company to another on credit terms. It is not available to insure against the possibility that members of the public fail to pay.
Invoice discounting is offered by banks and by certain lenders who specialise in commercial finance.
Improved cash flow
The most obvious advantage of invoice discounting is that funds arrive in your company earlier than they would otherwise have done. If you issue an invoice, you have to wait for payment, and you cannot know whether it will be 30 days, 60 days, 90 days, or even longer, until payment is received. Invoice discounting introduces a guarantee that funds will be available at a certain time, and thus greatly improves your ability to meet regular expenses such as salaries, rent or mortgage payments, utility bills and repayments on other loans.
Pay your suppliers quicker
Receiving early payment on invoices can allow you to pay your own bills faster, and so you may be able to benefit from supplier discounts for early payment.
Invoice finance can be arranged and advanced in as little as 24 or 48 hours.
There is no need for you, or your lender, to inform your customers and suppliers that you have entered into an arrangement of this type.
An invoice discounting lender will allow you to insure against the possibility that the buying company goes bust before paying your invoice. If you look hard enough, you may be able to provide a lender who is offering this ‘bad debt protection’ for free for a limited period. Like any debt, an invoice discounting lender will require you to repay the loan, even if the customer becomes insolvent.
Individual negotiation on costs
Unlike many forms of borrowing, the lender may not have standard interest rates and fees. You should expect to be able to negotiate these with the lender.
Compatibility of online systems
An invoice discounting lender may have an online facility that can be integrated with your accountancy software package. You can thus view your ledger data online at any time.
Funding of expansion
If your working capital position improves, you will be better placed to invest with the aim of growing your company.
Facility grows with your business
Invoice discounting is based on a percentage of your outstanding invoices, so as your company grows, your invoice discounting facility grows with it. Contrast this with a traditional overdraft, which will be for a fixed amount, and if your company expands, you may need to re-negotiate an increase.
Making use of invoice discounting can massively reduce the amount of time you need to spend on reconciliations.
Whilst invoice discounting may be more expensive than some forms of borrowing, it is likely to be cheaper than factoring, another form of invoice finance, as with discounting you retain control of your sales ledger rather than pay a third party to do this.
Difficulty obtaining credit
It tends to be smaller companies that experience the biggest difficulties with cash flow, yet invoice discounting is difficult to obtain for smaller companies. In recent years lenders have been increasingly unwilling to lend in any form to small enterprises. Before invoice discounting is considered, most lenders will require the company to have a particular level of annual turnover, say £500,000 or even £1m, and will require the company to have established payment and credit control systems. They may also require you to have been trading for several years.
There are some niche companies which specialise in invoice finance for smaller companies, but these are few and far between, and are likely to charge higher fees.
Another possible impact of invoice discounting is that it can make obtaining other borrowing more difficult, as you need to provide security for your invoice finance.
Whilst invoice discounting may be specifically designed to help with cash flow in case of late payment of amounts due, it is likely to be more expensive than a bank loan or an arranged overdraft.
As with any form of borrowing, a company seeking invoice finance will have their credit worthiness assessed by a potential lender. Credit worthiness may be assessed using evidence from many sources, such as:
- Media reports about the company
- Data obtained from suppliers and other parties the company works with
- The company’s financial statements
- The company’s track record in meeting previous loan obligations
Simply having a credit check performed can harm your company’s prospects. It may be essential to undergo the credit check in order to be granted a loan, but if your application is declined, you suffer the worst of both worlds, as the fact that you have failed one credit check will reduce your chances of obtaining other credit in the near future. So if you think it is unlikely you will pass the credit check, don’t make a speculative credit application.
Restrictions on invoice discounting
Invoice finance can be difficult to obtain for smaller companies, as we have seen, but it may also be difficult to borrow in this way if your company engages in lots of small transactions, if the credit is likely to be required for a long period or if the transaction has an international element.
Reliance on invoice discounting
Once an invoice discounting arrangement is in place, it can be difficult to end it. The company may start operating on the basis that the improved cash flow arrangements will always be in place, and the continual need to borrow could lead to the company becoming trapped in a debt cycle.