Invoice discounting: What is it?

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    Michael David

    Page written by Michael David. Last reviewed on July 11, 2024. Next review due October 1, 2025.

    If you frequently find yourself waiting on clients to pay your invoices, there’s a way you might be able to speed things up. Invoice discounting is like getting a cash advance as soon as you issue an invoice. Here’s how it works. 

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      What is invoice discounting?

      Invoice discounting means borrowing against unpaid invoices that are owed to you in order to receive your money faster. It’s called “discounting” because, although you are able to access your funds more quickly, the amount you receive will be discounted by a fee that you pay to the finance company.

      How does invoice discounting work?

      Invoice discounting is like being able to access a short-term loan that is secured by your accounts receivable. Here’s how it works:

      • You sign up with an invoice discounting company. You’ll want to shop around, as the specific services and fees can vary quite a bit.
      • You issue an invoice to your customer and send a copy to the discounting company. It’s going to be your responsibility to track your invoices and make sure you get paid.
      • The invoice discounting company sends you funds. Once an invoice is approved, you will receive an advance for most of the value of the invoice.
      • You collect from your customer and repay the loan. Once the money comes in, you repay the invoice to the discounting company, plus a fee that typically varies between 1% and 3% of the amount borrowed.

      In some cases, the invoice discounting company will prefer to have your customers pay directly to an account held in trust for you. This makes the transaction less risky for the lender and does not have any negative impact on you or your clients.

      Example of invoice discounting

      Alex runs a small manufacturing company and just billed a client $10,000 for finished goods. He submits a copy of the invoice to his invoice financing company and they send him a $7,500 advance immediately, which is equal to 75% of the invoice — a typical advance percentage. When Alex gets paid by his client, the money goes straight into a trust account with the finance company. They deduct a 2% financing fee, which works out to $200, and send Alex the remaining $2,300.

      In essence, Alex agreed to be paid a total of $9,800 instead of $10,000 in exchange for receiving most of his money right away, so he could cover the expenses related to completing the job.

      What is confidential invoice discounting?

      Invoice discounting is generally confidential, meaning that your customers will never know that you are working with a finance company. You are the one issuing the invoice to your clients and you are also the one responsible for collecting what they owe and repaying the loan from the finance company. Your financing arrangement remains private.

      What is the difference between invoice discounting and invoice factoring?

      With invoice discounting, you handle all of the customer interactions yourself. Any borrowing arrangements you make are between you and the invoice discounting provider. With invoice factoring, you are selling the unpaid invoices to the invoice factoring provider, and they collect the money directly from your clients. This means your clients will be dealing with a third party.

      There is another potential difference: invoice factoring can be done on a non-recourse basis, which means the factoring company takes the risk of clients who fail to pay their invoices. With invoice discounting, however, you are always responsible for repaying the loan, even if your client doesn’t pay.

      Advantages of invoice discounting

      Cash flow management is a challenge for many businesses. Invoice discounting is a financing tool that can offer access to capital very quickly and at a relatively low cost. Here are some of the advantages:

      • Better cash flow. Access to cash when you need it.
      • Speed. An invoice advance can be obtained in a matter of days or even hours.
      • Confidential. Your clients will only deal with you and will not be aware that you are using a financing service.
      • Built-in collateral. The invoice itself is collateral, meaning you don’t need to provide any further collateral. 
      • Cover expenses. Use the funds for payroll, supplies, rent, or any other time-sensitive expenses.
      • Seize opportunities. Have money for opportunities like advertising, marketing, or hiring key people.

      Is invoice discounting right for my business?

      Invoice finance is one of many business financing options. You might also consider invoice factoring, which is similar in many ways, or other alternatives, such as a short-term business loan, business credit card, business line of credit, merchant cash advance, small business grant, or microloan

      The business financing solution — or combination of business financing solutions — that you choose will depend on many factors, including how fast you need the funding, how much you are willing to pay in interest and fees, and your overall financial picture, including your years in business, revenue, and credit score.

      Get started with Swoop

      Looking for ways to smooth out your business cash flow? Look no further. Swoop will scan the market for the best business financing options out there and deliver them to you in minutes. Check your financing options now. 

      Written by

      Michael David

      Michael David is a financial writer and former investment advisor. Writing for Capital Group, Dimensional Fund Advisors, Franklin Templeton Investments, HSBC, Invesco, PIMCO, Vanguard, global insurance companies, major banks and others, he has educated professionals, business owners and consumers about strategies for investing, insurance, banking and corporate finance for more than 20 years.

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