What Is Invoice Discounting & How Does It Work?

Learn all about invoice discounting, how it works, and the pros and cons of using an invoice discounting facility.

Updated: February 12, 2024
Matt Crabtree

Written By

Matt Crabtree

|
Rebecca Goodman

Edited By

Rebecca Goodman

 

Waiting for your client or customers to pay invoices can cause cash flow issues and put a stop to your day-to-day business activities, especially if you're a small or medium-sized business.

Invoice discounting is one solution to help you gain access to cash through your unpaid invoices and allows you to tap into the value of their sales ledger.

In this article, you'll learn all about invoice discounting, how it works, and the pros and cons of using an invoice discounting service.

What is invoice discounting?

Invoice discounting, sometimes called confidential invoice discounting, is an alternative to traditional finance options. It is a type of invoice finance that works a bit like a business loan.

Invoice discounting ensures you can quickly access money until your customer payments come through. You share your invoices with a company specialising in invoice discounting, and they'll lend you a percentage of the invoice value. Once the customers pay the invoice, you repay the loan. You will repay the amount borrowed plus any fees from the remaining balance.

Invoice discounting is only one invoice finance solution and it is different from discount factoring. Invoice discounting is usually confidential, meaning your customer doesn't need to know that you're using invoice discounting providers, so your customer relationships are maintained.

Invoice factoring involves selling some or all of your business's outstanding invoices to a third party, and confidentiality isn't necessary. Invoice factoring includes the third party taking over credit control processes, whereas, with invoice discounting, you continue to manage your own credit control processes.

How does invoice discounting work?

Now that you know what invoice discounting is, you'll need to understand how it works and how to use it to your business's advantage.

  1. You conduct business as usual: you should be carrying on business as usual, providing your everyday goods and services, and when it's time to raise invoices for the services, you'll send them to your customers as you usually do
  2. Find an invoice discounting company: when looking for an invoice discounting provider, you must decide if you want to discount your business's entire accounts receivable ledger and if you want to submit all invoices or select ones. You must think about credit terms, loan length, and interest rates.
  3. Get paid invoice value: the invoice discounting provider will lend you the value of the raised invoices minus a percentage. You will receive the amount once the invoices are verified.
  4. You collect invoice payments: your customers should pay you as usual. If there is a late payment, you should follow your standard process, and as you're the credit controller, it is up to you to chase customers. Once you've received the payment, you must repay the loan to the invoice discounting company plus any agreed fees and interest.

Invoice discounting: the pros and cons

Invoice discounting is a short-term loan solution, with pros and cons:

Pros

✔️ Improve cash flow problems: if delayed unpaid invoices are causing cash flow problems, invoice discounting can help bridge the gap until the customer pays you

✔️ Speeds up the working capital process: invoice discounting provides instant access to cash tied up in outstanding invoices. So, if your business needs money before the customer can pay, invoice discounting acts as a short-term loan.

✔️ You retain control: you can choose selective invoice discounting, where you only share specific invoices with the lender. You can continue to manage your own credit control processes, not the finance provider.

✔️ Facilitates early payments for suppliers: if you need or want to pay them early, you can get money from invoice finance solutions and repay it when collecting customer payments

✔️ Confidential invoice discounting: your customers won't know if you use invoice discounting

Cons

❌️ Challenging to obtain credit: a small business may need help finding an invoice discounting service that will accept them if there isn’t much company credit history

❌️ Reliance on discounting services: although invoice discounting is a great way to increase cash flow, it is only a short-term solution. The convenience of it may tempt you into becoming too reliant on it, and in the long run, you will lose a lot of money in the interest you pay.

❌️ Pay interest on the borrowed amount: although you only borrow a percentage of the invoice value, you have to pay interest on the amount you borrow and possibly even fees. So, you'll always end up paying more than you borrow.

Final thoughts

Invoice discounting is a convenient short-term solution for cash flow problems but shouldn't be used as a long-term solution. It's great that you can get quick access to money, but you will always have to pay back more than you borrowed, in interest and fees, so think carefully before choosing it.

If you consistently rely on invoicing financing to help push your business along, you should seek help from a financial advisor for long-term solutions and advice on business finance.

Related Guides:

What Is invoice discounting and how does it work: FAQs

What is the difference between invoice discounting and invoice factoring?

Why would you need to hire an invoice discounting facility?

What are the advantages of invoice discounting?

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