What is invoice discounting?
Finance for recruitment agencies

What is invoice discounting?

Invoice discounting is a type of short-term cash flow finance option that allows a business to access instant funds secured by the value of their accounts receivable ledger. A line of credit can generally be extended to a company for a percentage of the total ledger’s value (usually 75-80%). As invoices are paid, this credit amount is automatically repaid and allows for redrawing against new invoices created and awaiting payment.

It acts as a revolving line of credit more closely aligned to a business’ expected income. It is designed to reduce cash flow strain, free up money for investing in new growth opportunities, and help cover day-to-day expenses.

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What is invoice discounting for?

When businesses provide goods or services to their customers, they issue an invoice along with those products or services. Payment terms are the agreed-upon period that a business must wait before that invoice is paid. In the intervening time, however, that business still has operating costs to pay, like overheads and employee costs. Invoice discounting bridges the gap until the customer pays their outstanding invoice.

Invoice discounting helps to solve cash flow issues not only because businesses are not forced to wait 30 days or more for payment from their business customers, but also because repaying the credit amount doesn’t further strain cash flow resources.

A shortage of working capital is a serious problem for most businesses. Cash flow problems are a headache for almost 50% of companies in Australia. With credit terms on invoices sometimes up to 90 days, securing funds against them provides an instant cash boost that can be put straight to work.

Invoice discounting is often known by other names, including invoice finance, accounts receivable finance or debtor finance. These terms describe the broader category of invoice financing, and invoice discounting is a specific type. Invoice discounting is very similar to factoring, with some key differences.

How does invoice discounting work?

The finance provider will review a company’s sales ledger during the application process as part of their lending criteria checks. The sorts of things they are looking for include the concentration of debtors on your ledger, their creditworthiness and the age and value of invoices. It is generally considered better to have multiple debtors spread over multiple invoices rather than a concentration of only a few debtors.

Based on the information they glean from your accounts receivable ledger, they will advance you a proportion of that ledger’s value, usually around 75-85%. They will then set up a new receivables account for your business where the outstanding invoices you have financed must be paid into.

This kind of credit is designed to grow with a business. As more invoices are raised, more funds become available without needing further credit applications and additional credit checks.

Types of invoice discounting

There are a few different types of invoice discounting:

Confidential invoice discounting

This is the most common form of invoice discounting, where the facility is not disclosed to a business’ customers. This allows a business to manage all of its customer relationships as usual, offering a discrete boost to cash flow. It also means that collecting debts remains with the company, which may be a pro or a con, depending on the kind of credit control resourcing available.

Disclosed invoice discounting

Alternatively, there are finance facilities available where the arrangement is known to customers; however, the lender does not assume responsibility for collecting invoices and remains with the company.

Selective invoice discounting

For invoice discounting facilities, funds are usually raised against the entire accounts receivable ledger. However, selective invoice discounting allows individual invoices or customers to be selected for financing instead.

Disclaimer: always refer to professional advice. The information presented here is purely indicative and not intended as advice. Always consult a legal or finance professional.

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