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What is Invoice Discounting? All You Need to Know

June 28, 2021 Hasib Howlader What is Invoice Discounting? All You Need to Know

Cash flow is always a crucial consideration when running any size of business. There are multiple financing options out there with a range of pros and cons, including invoice discounting.

Here we'll explore this option, and see when it's a viable option to help your company raise vital funds without taking on excessive debt or extra borrowing.

As always, it's advisable to seek professional advice when considering any credit facility (and ensuring you know all the potential pitfalls). 

If you have cash flow concerns and need independent guidance, please give the Hudson Weir team a call for support with managing company debts.

What is invoice discounting?

Your customer debts are often one of the most significant assets on your balance sheet. 

They're also secure and stable, particularly if you trade with customers with a solid credit rating.

Invoice discounting is primarily used to generate faster cash inflows rather than waiting for your customers to pay.

In essence, you're borrowing against your sales ledger and paying the provider a fee (more on that shortly) for the privilege.

It's a bit like a series of short-term loans, with the invoice used as security. The lender knows you will repay them, so it's a simple way to boost cash flow without getting into longer-term debt.

Fees vary depending on the facility size, lender risk and sector. You're usually looking at around 0.2% to 0.5% of company turnover as a service charge. 

The discounting fee is the cost of the borrowing, levied each time you use the facility. It's typically between 1.5% to 3% over base rate, charged daily.

How does it work?

If you're wondering what invoice discounting is and whether it’s right for your company, let's run through exactly how it works:

  1. You have a maximum credit facility, against which you can borrow and leverage your outstanding customer debts
  2. The business issues an invoice and borrows up to a fixed percentage of the value from their lender (usually up to 80% or 90%)
  3. Once the lender has received a copy of the invoice and any verification they need, such as a POD, they transfer the cash directly to your bank account
  4. You'll still need to deal with your accounts receivable ledger, collect client payments and chase up late invoices, but you can borrow against your debtor balances as and when you need to

Of course, you need to pay the borrowing back when your client pays and cover the associated discounting fees.

However, invoice discounting can be a lifeline for businesses that trade on extended payment terms or need help injecting more capital into their cash flow.

It's often a more viable borrowing option for businesses with any credit issues. The security is tied up in the customer invoice, not in the assets or profits of the company.

Is invoice discounting the same as invoice finance?

No, invoice discounting isn't quite the same thing as invoice finance.

Invoice finance (or factoring) works similarly. However, the key difference is that you pass over responsibility for collecting the debt to your finance provider.

There are good and bad aspects to that:

  • Good: your customers may never know you use an invoice discounting service
  • Bad: you still need to chase up accounts and manage late remittances
  • Good: your account fees will be lower since you aren't paying for credit control
  • Bad: you won't usually get the built-in insurance cover against customer liquidations

Again, it's well worth seeking professional help if you can't decide between invoice discounting or invoice finance or aren't sure which solution is the best fit for your business demands.

Company closures and invoice discounting

Let's consider a worst-case scenario:

  • Your customer goes bust, and you've borrowed through an invoice discounting facility against their invoice

If you have a client who enters liquidation, it will inevitably cause stress. The problem is that you still owe your invoice discounting provider the debt - plus fees.

One of the best ways to avoid this crisis is to take out bad debt protection insurance.

Just about all invoice discounting lenders will offer the option, or you can opt for separate insurance to protect yourself if a customer cannot settle their debts.

Otherwise, we'd recommend speaking to your discounting service immediately, so they're up to speed with the situation. 

In some cases, you might be permitted to set up a repayment plan, or request an extension. This would give the business breathing room to make good on their borrowing.

As with any trading problems, the key is to seek independent advice so you're on board with all the available options.

Contact the Hudson Weir team for further guidance and to assess whether invoice discounting is the perfect cash flow solution for your business.

ACCAThe Association of International AccountantsICAEW Authorised Training EmployerICAEW Licensed Insolvency Practitioners (UK)Insolvency Practitioners AssociationR3
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Hudson Weir are an established firm of Insolvency Practitioners who specialise in business recovery and corporate financial solutions.

Hudson Weir provides industry leading, nationwide services for its clients with the intention of easing financial pressures and providing recovery strategies for struggling businesses.

Hudson Weir Ltd (Company number 09477593) is a company registered in England and Wales.

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