Invoice discounting is a method that can be used by businesses to draw money against invoices and improve cash flow. Contrary to invoice factoring, the business retains full control of its own sales ledger.
Invoice discounting is not suitable for all types of business. It is only available to businesses that sell services or products to other businesses on credit. The business must usually have an annual minimum turnover of £500,000 and a proven track record.
The way invoice discounting works is that the discounter will first carry out a check on the business, including its customers and its systems. If the check’s results are acceptable, the discounter might choose to advance an agreed percentage of the total amount of the sales ledger outstanding.
The invoice discounter will charge a fee to the business, which is usually a percentage of the total value of the invoices or a fixed fee that the two parties agree. There is also likely to be a charge of interest on the net amount that is advanced.
Once details of the outstanding invoices have been agreed, the discounter will make a percentage of the total amount outstanding available to the business to draw on as it is needed. When the business receives payment of any of the invoices, this is passed to the discounter to reduce the outstanding balance. The business can also notify new invoices to be assigned to the discounter, to further increase the funds available. This can be a long-term arrangement with available funds growing as a business expands.
One benefit of invoice discounting is that because the business retains control over collecting its outstanding debts, customers are not normally aware that invoice discounting is in place. The discounter will usually, however, keep a check on the procedures of the business for managing the sales ledger to make sure they are effective. If invoices remain unpaid, the business might opt for the discounter to become involved in the credit management at that stage.