In business you have a few ways to obtain money. You have a regular business loan, which is offered with an interest rate from a bank or building society. These loans are regulated by the Bank of England and UK laws. Unfortunately, there are times when loans are not attainable for a business. Loans are offered based on your risk and credit worthiness. If the risk is too high a bank may refuse you. This leaves you with other financial funding options like invoice discounting.
You should not confuse invoice discounting with invoice factoring, as the two are actually different processes. Invoice discounting is a type of borrowing where as invoice factoring is the direct sale of an invoice without need for repayment on the money given.
Now that you know there are differences, we can concentrate on how invoice discounting works in order to examine what invoice discounting is. As a short term borrowing option businesses are able to obtain capital and cash flow in order to continue their company business.
With invoice discounting you will receive money against a sales invoice before the customer has paid you. You approach a company offering invoice discounting and they will tell you the percentage you may borrow based on your sales ledger. The unpaid sales invoices are used as collateral for any borrowing you do.
Most companies offering invoice discounting allow you to draw up to 80 percent of the amount owed on that invoice. This provides you with funds before you would otherwise get them from the client. When the customer pays on that invoice and when new sales are raised you can draw more from your sales ledger and therefore the finance company.
The finance company needs to make money in order to remain in business. They do not provide invoice discounting for free. Instead they charge you, the business, a monthly fee. They also require an interest payment against the amount you borrow. Invoice discounting has its risks, which means finance companies may refuse to allow some invoices to be used in the invoice discounting process.
They may refuse if they feel your client is one with credit risk. They may also refuse invoices from overseas sales, long credit terms sales, or small value invoices. Finance companies ask for regular reports to be sent given the credit control stays with your business rather than with them. They just want to make sure you are acting responsibility with the sales amounts you have.
There are many benefits to invoice factoring like obtaining the cash before you otherwise might. The business also only pays interest on what is borrowed rather than what is available. It is a lot like overdraft in that way and also tends to be more flexible than the factoring option. Invoice discounting is confidential so that suppliers and customers are unaware of your business borrowing against the sales invoices before you are actually paid. As with any product there are drawbacks to be concerned about before you make your decision.