What is invoice discounting

Invoice discounting is another form of invoice finance.  The key differentiator between invoice discounting and invoice factoring (for example), is that it is very much a ‘back of house’ solution – your customers will generally be unaware that you have a finance partner involved.

The main reason businesses look to short term finance solutions is to improve cashflow.  By gaining access to the funds from your account’s receivables (outstanding invoices), you are able to bring your own cash back into the business sooner.  This can be particularly useful for SMEs as it is scalable and very much designed to grow with your business.

It works like this:

At the start of the relationship, the Financier will review your debtors, sales ledger, creditworthiness, the value of your invoices and projections.  This will help them determine the risk in offering you an invoice discounting solution.  On approval, the Financier will advance you a proportion of the total value of your ledger, usually between 75% and 85%.  On payment of your invoices, they will deliver the balance to your business (less their fee).

Sending out invoices as soon as work is completed is key to the success of this kind of cashflow finance solution.  Raising an invoice and then getting paid immediately can create many efficiencies in your business with better delivery, forecasting and planning delivered by steady cashflow.

Is invoice discounting right for me?

With so many alternative financing options now available to small business, it can be hard to know which will be most appropriate for your business.  Invoice discounting can be a great option for a business that:

  • Have long lead times between starting a project and issuing the final invoice
  • Work in industries like infrastructure, manufacturing, wholesale or government
  • Have a growth opportunity and is required to upscale quickly
  • Have a workforce that is paid weekly but outstanding invoices at 30, 60 days (or longer).

Here’s an example:

Your business specialises in providing labour-hire and engineering for the commissioning and close-out of major projects in the mining and heavy industry sectors.  

As a small business, you jumped at the chance to work on a large project as it would mean steady revenue for at least a year.  You needed to hire new equipment as well as add to your labour force to get the project up and running.  You quickly found yourself facing significant cashflow issues as you tried to meet your obligations to your employees while waiting anywhere between forty-five and sixty days for your own invoices to be paid.  You were regularly dipping into your overdraft, and all the certainty you had hoped for at the beginning of the project was replaced by worry and stress.  

A friend, working in a similar field to you suggested invoice discounting as a way of accessing some much-needed funds to help run your business.  Initially sceptical, as you were worried about how your client would perceive third party involvement.  You were happy to discover that an invoice discounting solution (as opposed to invoice factoring) does not require any disclosure or insist on a relationship with your client.  

Through setting up the facility you quickly cleared all your cashflow headaches through steady working capital flowing in to the business.  You now have your largest ever labour force (over 90 people) employed, with no concerns about meeting your obligations to them. You are even starting to look at opportunities for expansion.

Types of invoice discounting

Before we look at the pros and cons of invoice discounting we should explore invoice finance in Australia a little more.  With so many finance companies offering funding for SMEs based on an invoice finance model (leveraging the value of outstanding invoices) it is really important that you seek advice and review all the options available.

The three types of invoice finance:

1. Confidential 

The facility is not disclosed to your customers.  You maintain your relationships as normal, retain control over your ledger including chasing payments.  This discrete ‘back of house’ option offers a boost to your working capital without any intrusion on your relationships.

2. Disclosed

Usually called invoice factoring, this solution will take control (or buy) the whole ledger of your business.  It is an arrangement that your clients will be aware of, as essentially your finance partner takes overall management, including debt collection.  This could be seen as a pro or a con depending on your situation.

3. Selective

For most invoice discounting or invoice factoring products, funds are usually raised against the entire account’s receivables ledger of your business.  Another option to consider is selective invoice finance – this means you can pick and choose which invoices you wish to fund, when and at what percentage <LINK Apricity>. This is very much an ‘at call’ form or finance, that you can use as much or as little as you need to.

Pros and Cons of invoice discounting

Pros of invoice discounting:

Improved cash flow – you are able to meet your operational costs, pay your employees, fulfil orders and grow

Supports growth – the facility grows with you, as more invoices are raised, the amount of working capital back into your business increases

Fast funding – your business can receive payment within 24 hours

It’s not a loan – you are accessing your own capital, you are not taking on a bank loan or required to put at risk any personal assets as collateral

Control – you remain in control of your client relationships.

Cons of invoice discounting

Cost – invoice discounting can be expensive; your business must weigh up all invoice financing options available as well as the value you place on having funds back into your business (and back to work) sooner

Entire ledger is funded – you are not able to select invoices to fund, whether the invoice discounting solution is ‘confidential’ or ‘disclosed’ generally the whole ledger is funded

No admin support – unlike factoring where the financier takes control of your ledger (this could also be considered a pro for some businesses)

Availability – some financiers will look unfavourably on small businesses or those that have highly concentrated debtors.

In conclusion

Cash remains key to the success of any business and a product that leverages invoices is a great way to stabilise cashflow, meet operational costs and plan for growth – all without taking on further debt.

Sometimes businesses worry about disclosing that they are using an invoice finance facility to their clients.  However, in our experience this is rarely a genuine concern for your clients.  Invoice finance and other products is recognised now as a very clever and efficient way for businesses to manage their cashflow.  With bank finance continuing to be difficult to obtain for many businesses, looking at other options to keep your business moving makes good sense.  In fact, often our clients will ask for a letter of support from us when tendering for large contracts.  Their clients know that a facility like ours will help ensure the business can stay afloat between invoice payments.

When considering invoice factoring vs invoice discounting, both of which will provide a cash injection of your own money sooner, the decision really comes down to visibility and control.  While some businesses see advantages in selling their ledger and relinquishing control to a third party.  Others argue that maintaining client relationships are of the utmost importance and would only consider an invoice financing solution that is not disclosed. Invoice factoring and invoice discounting generally take on the whole ledger of the business, so, for those looking for more control, a selective invoice finance facility could be a great option.

Find out more about the types of Invoice Finance available