Invoice Discounting Explained

Conrad Ford

Written by Conrad Ford on March 6, 2019

Updated March 6, 2019

man with business debt issues

Cash flow, or rather cash flow problems, are the primary reason most businesses in the UK fail. If a business can’t find the right balance between income and expenditure, it won’t succeed. Which is where invoice discounting comes in, allowing companies to better manage their cash flow by lending money against the value of outstanding invoices.

What is invoice discounting?

With invoice discounting businesses sign agreements with financial institutions (or lenders) who loan them money using unpaid invoices as collateral. Loans are designed to be short-term to cover any shortfalls in cash flow, though they can be used to support a business’ growth if you need to invest in stock or supplies for example.

Banks, building societies and other financial institutions offer invoice discounting. Each will have a slightly different set of eligibility criteria and fee structure. If you aren’t sure which is best for you, consider using a specialist Invoice Finance Broker who can provide you with a range of finance company options designed to meet your specific needs.

Who is eligible for invoice discounting?

Invoice discounting is designed for business to business (B2B) companies rather than those whose customers are consumers (B2C). Any B2B business is eligible, though it works particularly well for companies with large numbers of invoices, food and hospitality for example, or the recruitment sector. In general, finance companies will want you to have an annual turnover of at least £25,000 and provide credit terms to your customers of no more than 90 days. They’ll also want those businesses to be UK-based too.

If you only have a few customers or don’t invoice regularly, you might want to consider single invoice, or spot factoring, finance. This allows you to raise funds against one invoice at a time (though there might be minimums for the value of this invoice).

The benefits of invoice discounting

One of the things that attract businesses to invoice discounting as opposed to invoice factoring, which works in a very similar way, is that with invoice discounting you stay in control of collecting payments; in invoice factoring, this is done by the lender, which could put your relationships with your customers at risk.

Plus, because you’re collecting payments yourself, your customers don’t know that you are using invoice discounting, meaning the process is completely invisible, and there is less chance of any reputational damage.

When offering invoice discounting, the lender is relying on your ability to collect payment. They’ll want to know your invoicing and collection process are fit for purpose, which means you may need to provide evidence during the application process. They may also include the right to audit your accounts in order to confirm you are meeting the terms of any agreement in their terms and conditions.

The downsides of invoice discounting

As with all types of finance invoicing, the fees and charges for invoice discounting can be quite high, and it’s wise to check these before you sign any agreements. Fees may include monthly charges that are payable even if you don’t use your account so, if you don’t see this as a long-term financing option, it probably isn’t right for you.

As you are responsible for collecting payments, there could be significant charges if payments are late or not made at all. It’s a good idea to take out insurance which covers you if a customer doesn’t pay; if not, your assets may be at risk as the lender will expect you to pay back any advance.

How to apply for invoice discounting

You apply for invoice discounting in the same way as you apply for other types of funding – by filling out an application form and providing the finance company with key documents including your annual accounts, accounts receivable aging report and an overview of your organisation and the invoices you expect to submit. This allows the lender to perform their due diligence.

Once this is complete, they will provide you with an agreement that outlines their terms and conditions and open an account you can use at any time to claim cash against unpaid invoices.

In just the way lenders complete due diligence on your business, you should do the same on any potential finance company. Check out their financial standing, their customer reviews (asking for recommendations if needed), and make sure you understand their fee structure before signing any agreement.

The invoice discounting process

Once your account has been opened, the invoice discounting process has been designed to be easy to use:

1. Once you have sent an invoice to your customer, you submit this to the lender (usually through an online system)

2. The lender pays you a cash advance on the value of the invoices; this is generally anywhere from 80% – 95%

3. Your customer pays the outstanding invoice

4. You deposit the customers’ payment into the lender’s account.

5. The finance company pays you the outstanding amount due minus any fees

Some lenders let you submit individual invoices, others ask you to submit in batches. If you need to submit in batches, you’ll need to plan ahead, so you know you have enough money coming in from the lender to cover any costs.

Invoice discounting fees

Normally finance companies will charge you a fee to set up an invoice discounting account. They will then charge you a series of fees that could include:

  • An administration fee: This could be set as a percentage of the invoices you submit each month or as a fixed fee, regardless of whether you use the account or not.
  • A discount fee: This is a charge that covers the period between you receiving your advance and paying it back (after the customer pays you); this is the same as the interest you would pay on a loan.

You may be subject to other charges, for BACs transfers, for example, so make sure you understand what these are and factor them into any costs.

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