Invoice discounting: How it works and what it costs
The quick Growing Business guide to this form of invoice finance
What is invoice discounting?
Invoice discounting arrangements provide a means to borrow money against cash owed to you by your company’s customers.
When do I need invoice discounting?
Normally when an invoice is raised, it can take anything from a couple of weeks to several months before the debt is honoured. Meanwhile, as you wait for your customer to sign and send the cheque, your own bills are mounting.
It’s this gap between invoicing and payment that can create real cashflow problems. If this is a problem for your company, you should consider an invoice discounting facility.
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How does invoice discounting work?
Invoice finance is provided by a range of lenders who will advance you a percentage of the money owned on your invoices as soon as they are raised.
This means that money will go into your account immediately, regardless of how long in takes for a customer to pay after invoicing. Generally speaking, lenders won’t provide money equivalent to the full value of each invoice – 75% to 90% is more common.
Once the customer has paid the invoice, the remainder of the sum you have invoiced for will be paid, less the invoice finance lender’s charges.
How much does invoice discounting cost?
Invoice discounters are lending you money and you should expect interest rates of between 1.5% to 3.0% above base rates plus a management fee of between 0.2% and 0.5% of turnover. This obviously reduces your profits but it can be price worth paying for predictable cashflow based on your invoicing.
Invoice discounting is often confused with factoring. Both services fall under the umbrella of invoice finance, but the main difference is that factors chase debtors on your behalf while invoice discounters allow you to keep your credit control and invoicing in house.
It is this confusion that has often made this source of finance unattractive to business owners, as the suggestion has been levelled that it is for failing or weak businesses incapable of balancing their books.
There is an element of truth in this as insolvency practitioners will often use it to help struggling businesses get back on their feet, but generally speaking the reputation is undeserved and the benefits are largely understood.
Invoice discounting and factoring services are often provided by the same lenders but the management fees for the former are much lower.
Invoice discounters will expect you demonstrate that you are an established profitable business with audited accounts and a sound credit control management (including invoicing) procedures in place.
For further information on borrowing against your invoicing, contact your business banker or an independent specialist provider.
A full list is available from the Asset Based Finance Association (ABFA), formerly known as the Factors and Discounters Association (FDA), at www.abfa.org.uk.