Credit Management Finance invoice finance
5 mins read

Invoice discounting – advantages, disadvantages and how it works 

Invoice discounting, also called invoice finance and cash-flow finance, can be a useful financing tool for businesses looking to take advantage of early access to money that they are owed. So long as they are diligent, they may be able to leverage this revenue to improve the profitability of the enterprise. Let’s explore the advantages and disadvantages of invoice discounting and how it might assist your business. 

What is invoice discounting?  

Invoice discounting involves taking out a loan for the value already owed by another commercial trading partner in your accounts receivables. In other words, you use a third party to forward pay you a percentage, up to 95%, of an amount you’ve invoiced to a business client. Once you receive payment from the client, you repay the loan, along with a predetermined percentage of the invoice as a fee, to the lender.  

Universally speaking, it cannot be said that invoice discounting is a wholly good or bad process for a business to undertake, as this depends on your specific financial situation. There are some advantages and disadvantages that accompany it, which are outlined below, and each business must undertake its own cost-benefit analysis before determining if invoice discounting suits its needs.  

For example: 

Say you invoice a client business for $1000, but you know that they may take a number of weeks to pay. If you wish to gain immediate access to up to $950 (95%) of this money, you could engage an invoice discounting service provider.  

The fee that it takes to allow you this flexibility usually amounts to between 1% and 3% of the invoice total. If we assume 3%, that would represent $30.  

This means that the net revenue from the invoice has been reduced by $30 to a total of $970, however, the advantage is the flexibility of being able to use the money right away.  

Invoice factoring vs discounting 

Invoice discounting and invoice factoring are both forms of invoice finance, however, there are some distinctions, most of which refer to who ‘owns’ the invoice.  

In the case of invoice discounting, the company that issued the invoice remains the owner of it and is responsible for collections actions taken to recover it, leveraging tools such as branded letter templates from CreditorWatch Collect. A loan is taken out on the invoice, however, the amount remains payable to that entity. Liability for non-payment in such instances usually falls to the invoicing company and it must service the loan borrowed on the invoice regardless.  

In instances of invoice factoring, the invoice is sold to a third party who then becomes responsible for the collection. The amount owed is now payable directly to that third-party, who often takes on the liability for non-payment. The initial company that invoiced the client is usually considered paid out and free of further obligations pertaining to that amount. Invoice factoring can apply across a whole sales ledger, whereas invoice discounting typically refers to individual invoices.

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What are the disadvantages of invoice discounting? 

  1. It reduces the net profit from an invoice 

If you make use of invoice discounting then between 1-3% of the total value of the invoice will be lost in fees to the lending party. This ultimately means that, although you can put the money to work sooner, the profit margin has decreased. You may be able to justify this by demonstrating that the early advance of money owed allows extra profitability to be generated elsewhere. However, your business will not receive the maximum amount from the invoice, compared to if they simply waited for the invoiced party to pay.  

  1. The perception of your company may take a hit

There is a certain negative stigma that accompanies many forms of invoice financing. If they discover your use of invoice discounting, clients may wonder why you need to advance the payment instead of simply waiting. It may give the perception that you are rushing to secure money in your accounts receivable out of a sense of desperation. Even if this isn’t the case, you may have to deal with some reputational fallout.  

  1. Invoice discounting only applies to commercial invoices

Unfortunately for those businesses serving the general population, or general public, invoice discounting can only be applied to commercial invoices (invoices to other businesses). While there may be other products, such as a business overdraft, available to address lags in money owed by the general public, the invoice discounting pathway is unavailable. Overdraft advantages and disadvantages are separate, and must be independently assessed.  

Steps to follow for invoice discounting invoices 

  1. Sell your goods or service

Provide your product to a client business to commence the transaction.  

  1. Generate an invoice 

Generate an invoice, ideally in your trade-payment platform of choice, outlining the products or services offered and the money owed.  

  1. Contact an invoice discounting provider

Speak to a third-party and formalise an agreement in terms of what percentage of the discounted invoice will be forward paid and what will be paid in fees.  

  1. Ensure the customer pays the invoice

Your company remains in control of the collections process. Use smart offerings such as branded letter templates from CreditorWatch Connect to reduce the Days-Sales-Outstanding (DSO) and risk of non-payment. Do your best to ensure they pay within the credit period outlined. 

  1. Repay the loan

Once the money has been paid by the invoiced client, you can repay the loan plus any relevant fees to the invoice discounting company. In some instances, you may be able to get the client to pay directly into an account overseen by the third-party, in order to prevent it from being lost in transit.  

Mitigate the risk of non-payment with CreditorWatch 

An essential component to any invoice financing solution is ensuring that you’re dealing with creditworthy entities, who are likely to pay their invoices on time and in full. Instances of non-payment may result in rapidly increasing debt obligations for your company, as you may still be liable for the loan repayments to invoice discounting companies. 

The gold standard for ensuring you trade with reputable businesses can be found in the CreditorWatch platform. We leverage extensive subsets of data, including trade payment data from over 55,000 customers, and advanced machine learning technology to deliver the most predictive payment indicator for client businesses on market. Utilising our RiskScore analysis, we deliver this credit risk information in intuitive and clear terms. Each business is scored from 0-850 (the higher the score, the more creditworthy the entity), and ranked in a credit risk tier from A1 to F. 

Empowered by our credit risk analysis tools, supported by 24/7 Monitoring and Alerts and CreditorWatch Collect resources to expedite payment, you can secure your cash flow and protect your business from bad debt.  

Speak to our expert team today about how CreditorWatch can support your invoice finance strategy.  

cash flow credit credit management finance invoice finance
Sarah Ward
Business Development Specialist | Credit management and Collections
Sarah is a highly experienced business risk, credit management, collections and business development specialist with over 10 years of experience. She is an expert in identifying and mitigating risks and has helped numerous businesses gain a deep understanding of the latest trends in credit management. Sarah’s recent work includes writing about high-risk businesses and how to identify them and providing insights on using a risk assessment tool like CreditorWatch’s RiskScore to make informed decisions. She also emphasises the importance of performing due diligence on new clients to assess their credit risk and mitigate cash flow risk. Additionally, Sarah has also written about cash control and how to improve debtor management. Sarah’s recent work includes writing about high-risk businesses and how to identify them and providing insights on using a risk assessment tool like CreditorWatch’s RiskScore to make informed decisions. She also emphasises the importance of performing due diligence on new clients to assess their credit risk and mitigate cash flow risk. Additionally, Sarah has written about cash control and how to improve debtor management.
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