Invoice Discounting Explained

Published by
Lethabo Ntsoane

Invoice Discounting solutions help companies leverage their accounts due to meet their immediate liquidity needs. Private and public sector businesses set their settlement date for goods to be supplied to suppliers and a longer settlement period can lead to a supplier being illiquid. 

Through invoice discounting, a company can solve its liquidity problems with the help of a financial institution. Government agencies, banks, fintech, and other financial service providers are among the institutions that provide this type of financing.

What is Invoice Discounting?

Invoice Discounting is a method of financing that uses the company’s accounts receivables as collateral to acquire financing. A financing company is one that lends money to another company in exchange for its receivables. The accounts receivables will cover the amount that the finance company has borrowed the company. 

 Most South African banks offer discounting financing with a 30-day repayment period. Fintech lenders, however, offer up to 365 days to repay the outstanding amount. The repayment period can be prolonged upon request but more fees will be incurred for the extension granted. 

Characteristics of Invoice Discounting

  • Financing companies provide funding in exchange for invoices that serve as collateral to the funds provided.
  • The repayment duration is short-term, however, an extension can be granted upon request.
  • Financing companies offer a lower percentage of the value of invoices with some money collected covering commissions and fees.
  • The borrower stays in charge of the collection of the accounts receivables.
  • Customers repay the borrower and the borrower is responsible for the repayment of the finance issued by the financing company.

Who does Invoice Discounting Works?

When goods and services are sold to the private and public sector individuals and businesses they are sometimes sold on credit. A business can leverage from its invoices that are not yet due by listing them as collateral to a Discounting company. 

A discounting company will finance a company up to 95% of the value of its invoices. The company will then receive cash from the discounting company from selling its invoices and it will be more liquid and will have immediate access to cash instead of waiting for accounts receivables to be paid. 

For offering finance in advance, the discounting company would get a financing fee. A financing fee is discounted when issuing finance to the borrowing company, for example, the discount company will issue 80% of the value of invoices minus the financing fee. 

The company financed will be in charge of the collection of invoices due from its customers. 

Advantages of Invoice Discounting

  • Expected cash is released quicker through invoice discounting finance. Invoices due are turned into liquid cash immediately.
  • Cash flow is improved immediately since 70 – 95% of the value of the invoice is paid to the company.
  • Assets are not part of the collateral, only invoices that are not yet due from customers form part of the collateral.
  • Unlike Invoice Factoring, with invoice discounting the borrower is responsible for the collection of money from customers. There won’t be any effects on business relations since the borrower will be in charge of correspondence with the customers.
  • More credit sales can be issued on credit since the company will be able to cope financially as there will be working capital available.
  • The borrower can control the accounts receivables by managing credit terms, negotiating further deals, and collecting payments.
  • The company’s information about invoice discounting financing will be kept confidential since the customers won’t know that the company had entered into an invoice discounting agreement. (the borrowing company is still responsible for the collection of debt unlike with invoice factoring where a factoring company is in charge of debt collection.)

Disadvantages of Invoice Discounting

  • The company’s profit margin decreases since expected profit will have to cover a fee that a Discounting company charges.
  • A discounting company may require that any future invoice discounting finance be done with the discounting company.
  • Start-up businesses may collapse because of this type of financing due to high-interest costs and maintenance fees associated with invoice discounting finance. It may eventually lead to dependency and cripple the profits of a business.

Documents that are needed when applying for Invoice Discounting

  • Latest financial information (management accounts and financial statements)
  • Latest debtors’ age analysis showing all the account receivables.
  • A valid tax clearance certificate.
  • Complete an invoice discounting application form. Depending on the financing company that you use this be done online.

Conclusion

Invoice Discounting is a good method of financing that can be used to sustain cash flow. Early payments can earn your business discounts and you will end up paying less fees than initially agreed. The solution helps businesses to continue trading and offer more services and goods to clients because production won’t stop due to cash inflow. 

The method has its own drawbacks. For example, debtors that take longer to pay can cost the company its profits since late payments will incur fees from the financing company.

Lethabo Ntsoane

Lethabo Ntsoane holds a Bachelors Degree in Accounting from the University of South Africa. He is a Financial Product commentator at Rateweb. He is an expect financial product analyst with years of experience in reviewing products and offering commentary. Lethabo majors in financial news, reviews and financial tips. He can be contacted at lethabo@rateweb.co.za

Published by
Lethabo Ntsoane