Invoice discounting is a way of obtaining quick finance for a business. It uses unpaid invoices as collateral against a short term loan. The loan is paid back by the business to the lender on maturity of the invoice when hopefully receipt of payment from their customer has been made. Finance companies can lend up to 100% of the invoices value and will charge a fee for the service.
Many small to medium businesses struggle to manage cash flow and it can become an issue. Sales may be high but if the waiting time for cash to be received from unpaid invoices is lengthy and doesn’t correspond with when working capital is required then problems can occur.
Invoice discounting is a great way to raise cash but it is important to understand how it works. Below are some of the advantages and disadvantages of invoice discounting and worth considering before deciding whether it’s the right way forward for your business.
Advantages of invoice discounting:
- Improves cash flow: As cash is raised as soon as the invoice is issued cash flow it can allow for better control over investment and growth decisions and improved business operations.
- It's a quicker way to obtain financing: Unlike other business loans invoice financing provides cash quicker with a reduced need for overdrafts or other debt facilities.
- No risk to assets: Invoice financing is an unsecured business loan paid in lieu of invoices.
- No impact on customer relations: As the invoice discounting company has no contact with the customer there is no need for them to be aware of the situation, customer confidentiality is maintained.
- Boost to credit sales: Invoice discounting takes sales made on credit and convert it into cash.
Disadvantages of invoice discounting:
- Overall profit is reduced: The discounting company charges a fee for the loan so in the short term there will be a decrease on the profits made. This can however be counterbalanced by opportunities gained with early access to cash providing increased access to business opportunities.
- Restricted availability: As this is an unsecured loan and risky for the lender, invoice financing is generally only available for commercial invoices which can be a barrier to business that deal only with the public.
- May not be the cheapest invoice finance solution: Comparisons should be made with other forms of loan, they may be cheaper
- Restricted financing: If a business is looking for a specific sum of money then loaning against their accounts receivables may not provide enough funding.