What is involved when a company enters into an invoice discounting arrangement with a finance company? More importantly, what is different about invoice discounting when compared to business loans, credit lines and factoring?
There are a couple of inherent differences that come with invoice discounting that might just be what your company needs to improve its liquidity and cash flow position.
Invoice discounting allows businesses to draw on their invoice’s unpaid balances to improve their cash reserves. It allows businesses to access easy funds to continue paying their day to day operating costs.
Cash flow is one of the biggest concerns businesses have today. Invoice discounting allows this to be a problem of the past.
How does invoice discounting differ from factoring?
Whilst factoring is a similar method of raising cash, there are some inherent differences. Factoring is based on selling a portion of the invoice’s value, receiving funds, and then paying a fee once the entire amount has been collected by the finance company.
In the case of invoice discounting, the company doesn’t pay a fee, but instead pays interest on the money it borrows from its receivables. In addition, the company may also pay a monthly fee for the invoice discounting service.
How does invoice discounting differ from business loans and credit lines?
Typically, the financing company will provide anywhere from 70% to 85% of the invoice’s value as a cash advance, and much like a loan, the company will then have to pay interest on the funds it borrows. However, unlike a business loan or credit line, the company uses its invoices as collateral and a form of credit.
It’s also much faster and easier to draw cash from. There’s also less of a risk of being refused. As the company gets paid for its invoices, it can either pay down its balance and interest owing to the finance company, or continue to draw on future invoices. However, it can not exceed the agreed upon payout rate of 70% to 85%.
Invoice discounting is more discrete than factoring:
Whilst factoring is a viable option, there are some drawbacks. The biggest drawback is that the factoring company will be responsible for collecting on invoices. As such, customers will come to know that the business is having cash flow issues.
In the case of invoice discounting, it’s more discrete and allows the company to draw cash without its customers being aware of its cash flow problems. This is likely why some companies prefer invoice discounting over factoring, and find it to be more flexible in the long run.
When companies need cash quickly, and simply can’t afford to wait for approval on loans, invoice discounting is often their best option. Whilst the company does pay interest on the money it borrows, and can pay a monthly fee for the service, overall the benefits are much better than going with the long and drawn out process of applying for additional credit.
Also, for businesses that are at their limit on credit lines and loans, invoice discounting becomes a much easier option to go with.