For a lot of small-to-medium-sized businesses (SMEs), credit terms can put a restriction on cash flow. In situations like this, invoice discounting can be a solution, serving as an external source of a cash infusion.
What does Invoice Discounting mean?
Invoice Discounting is a type of invoice financing where a seller acquires a short-term business loan, using their invoice as collateral. The business still has complete ownership of the invoice and therefore is still responsible for credit control and ensuring that the buyer settles their invoice. The buyer usually doesn't know that the supplier employs the use of a financier. Therefore, invoice discounting majorly involves two parties; The Supplier and The Financier.
How does Invoice Discounting work?
An illustration:
A company has a general credit term of 90 days to the public. They receive a large order worth 5 million. They deliver the goods and issue an invoice with an agreement of receiving payment after 90 days (as is their company's credit policy) but 27 days into Client A's credit agreement duration, they receive another large order from client B and do not have enough money to fund the order.
In a situation like this, the company (seller) can employ the use of invoice discounting. The seller takes the invoice issue to client A and uses it as collateral for a loan I.e they receive a loan against their accounts receivable. The financier would give the company a loan against his invoice, usually up to 80% upfront. The supplier can then go ahead to fulfil client B's order. When the supplier receives money from client A, he pays the financier back and gets the remaining percentage of the invoice balance minus a certain percentage agreed on as the interest and fee of the financier.
What are the benefits of Invoice Discounting?
In the case of the supplier, the major advantage of invoice discounting is that businesses can acquire cash immediately. This increases cash flow and ultimately increases the opportunities for business growth due to higher capital. The financial company offers a more flexible finance solution and it does not require any high-value assets as invoice serves as collateral. Another advantage of invoice discounting is the confidentiality it grants the supplier.
In the case of the financier, they can receive money in two ways, by charging interest on the loan and by charging a monthly fee for as long as they maintain the arrangement for the supplier.
What are the disadvantages of Invoice Discounting?
The major thing that can be considered a disadvantage to a supplier is that the business is required to pay a percentage of the invoice to the financier as a fee for taking a loan but compared to the loss that a company can incur due to restrictions on the cash flow, this might not be so much of a disadvantage.
Invoice Factoring vs Invoice Discounting?
Although both are types of invoice financing that can be used to increase cash flow freeing up capital held in invoices owed, invoice factoring unlike invoice marketing allows for the financier to completely own the invoice. This means that the financing company doesn't loan money to the supplier against accounts receivables instead, the supplier sells the invoice to the financing company at a discount and the financing company assumes ownership of the debts of the buyer.
This also means that the financial company in the case of invoice financing is responsible for ensuring that the buyer settles their invoice as opposed to invoice discounting where the supplier still owns the debt and is responsible for ensuring the invoice is settled.
Bill Discounting vs Invoice Discounting
Invoice Discounting is used to take a loan against an unpaid invoice up to a maximum of 90days while bill discounting acts as a bill of exchange ( A written order that binds one party to pay a fixed sum of money to another party on demand or at a predetermined date) and can be used for bills with credit terms between 30 days and 120 days.
Bridger and Invoice Discounting
Bridget is an African receivable financing platform and so we are concerned with giving you access to unlimited working capital held up in unpaid invoices. This simply means that in the case of invoice financing, we are the financing company. Usually, it might take a couple of days to qualify for invoice financing with a bank. It takes some hours with a Bridger (4hours-24hours).
With Bridger, you can expect to get at least 80% of the value of your account receivable and receive the remaining 20% minus a discount rate of a certain percentage per month when you receive payment on invoice.
Also on Bridger, we offer clients the opportunity to create, send and manage their invoices online and send and receive payment instantly. You can sign up on Bridger
Want to learn more about invoice factoring? Read our article here.