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If you’re running a small to medium business, you’ll know the importance of stable cash flow. It’s the vehicle that allows you to invest in additional resources, product development, and marketing and sales activity. 

And, of course, it ensures that you can pay your suppliers and creditors on time, a privilege that should not be taken for granted when it comes to your mental health. 

An innovative way to manage your cash flow is invoice discounting, and in this article, we provide everything you need to know about this finance method.

What is invoice discounting?

Invoice discounting is a form of business financing where your company sells its unpaid invoices to a lender (an invoice discounting company) who provides your business with a loan in return. 

The invoice discounting company pays you up to 90 - 95% of the value of the invoices, and you pay the money back once you have received the money owed to you by your customers.

How does invoice discounting work?

There are two types of invoice financing:

  1. Whole turnover discounting – you borrow against your entire invoice ledger. This method works well if you have reliable, long-term customers with a history of paying their invoices without too much chasing.
  2. Selective invoice discounting – only a select few invoices are discounted.

Below is a typical process for invoice discounting:

  • Your company sell goods and services and create invoices
  • The invoices are verified with an invoice discounting company
  • The invoice discounting company provides your business with advanced funds for the value of the invoices
  • You receive or chase up payments to your customers to pay
  • You repay the invoice discounting loan, excluding the agreed-upon fees

What is the average fee charged by an invoice discounting company?

An invoice discounting company will typically charge between 1%-3% per invoice to cover their administration fees and risks.

What is the difference between invoice discounting and invoice factoring? 

Invoice factoring involves you selling the entire invoice to a third-party company. Unlike invoice discounting, the third party controls the debt and can contact the debtor to collect the payment. 

Invoice factoring services come with the risk of your client relationships and business reputation being harmed by the debt recovery practices of the third party who owns the invoices. 

With invoice discounting, you retain your relationship with your client, and the third party don’t have to deal with them.

What is confidential invoice discounting?

You can arrange invoice discount financing, so it is confidential. This way, your customers remain unaware that your small business is receiving advanced capital against invoices that have not yet been paid.

Is invoice discounting a regulated activity?

Although there have been calls to regulate the invoice discounting sector, currently, it’s not regulated by the Financial Conduct Authority (FCA) or any other entity.

Is invoice discounting a good idea?

Invoice discounting provides a flexible cash flow management solution.

Provided you have a strong track record of successfully recovering monies owed from unpaid invoices via your existing processes and procedures, an invoice discounting company will likely want to partner with you. 

To manage their risk, most invoice discounting companies will require evidence of at least one year’s trading before agreeing to work with your organisation.

If you choose the selective invoice discounting option, as your business grows, you can choose more invoices to add to the discounting ledger, thereby increasing the capital available to your business. 

Furthermore, there are often no long-term contracts connected with selective invoice discounting.

Get legal assistance from LawBite

You need to try it to know whether or not invoice discounting is the right finance solution for your business.

However, there are disadvantages to be aware of, including massive fees and the time it takes to set up the facility. In addition, you will need a minimum turnover before a company considers providing the service to your business.

Our finance solicitors are here to assist you with any queries or doubts related to invoice discounting and the associated contracts and help you understand all the options concerning finance for your business. 

We can also review any loan or finance contracts you might have at an affordable rate. Book a free 15 minute consultation or call us on 020 3808 8314 to find out more.

Additional resources

In closing

Nothing in this article constitutes legal advice on which you should rely. The article is provided for general information purposes only. Professional legal advice should always be sought before taking any action relating to or relying on the content of this article. Our Platform Terms of Use apply to this article.

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