Accounting

Things you need to know about invoice discounting

Invoice discounting is a process in which a business can avail finances by offering the bills receivable as a security or collateral. After discounting a certain amount of the invoice or bills receivable the payment is carried out to make it more secure in case of bad debts. In other words, it is the advance payment that a company can get from the lenders by providing the invoices as collateral after discounting a certain portion from it. This credit received from the lender is then repaid once the customer pays the bill.

Chief benefits of invoice discountingare:

  • No other security or collateral needs to be provided for obtaining the credit
  • Can be very effective when there is slow payment. 
  • Instantly boosts the cash flow of the business and the working capital.
  • The everyday operations of the business can be carried out smoothly without worrying about the payment from the customers. 
  • It’s effective in incurring day-to-day expenses.

How does this work in practice?

Every day a business sends numerous invoices for providing services, handing over projects, or simply after supplying products or raw material. As per the agreement with the lender a certain proportion of money from each invoice is deposited directly to the bank account after the lender receives a copy of the invoice. The money earned from this can be used for paying outstanding debts, expenses or can be invested for the long-term goals of the company. 

To effectively implement and benefit from this you need to send the invoice immediately to the lender after the completion of the work. This ensures a perennial influx of cash. After the agreed amount of the invoice has been paid, which is on an average around 80% to 90 % of the total amount, the outstanding payment can be received from the customer normally. 

From the remaining amount, charges are claimed by or remitted to by the lender. There should be complete transparency regarding the fee structure and the charges to avoid any confusion. This should be made clear by the financer along with the other terms and conditions of the invoice discounting

How do you understand if invoice discounting is right for your business?

There are numerous ways to finance for a company and the alternative ways are not in any way less effective. This makes it difficult in deciding if invoice financing is good for is extremely important.

 However, here are a few factors that can tell if invoice discounting is good for your business. 

  • Your business has robust credit control procedures. 
  • You don’t have an outrageous amount of bad debts. 
  • Your customers are punctual when it comes to payments. 
  • Customers pay within 30 days of sending the invoice. 
  • Your business meets the minimum turnover as an eligibility criterion provided by the lender. 
  • As per experts one of the primary determining factors if invoice discounting is good for your business is if your carry out the entire project management process in-house. In case you don’t invoice factoring can be a more suitable option for you. 

These discounting services are mostly available for already established businesses vs start up. This is because the entire process depends upon the reliability of the turnovers and the trustworthy credit management process.

How to strike the best deal with your lender?

It is always better to get professional advice before going with any agreement with a lender to ensure you get into the best invoice discounting contract.

Operational charges and discounts are flexible and it varies from lender to lender. In case you don’t meet the exact criteria of availing of this service you might still get a lender. In that case, the lender may however limit the amount of cash advance or might charge a higher fee. Also, if you are dealing with an industry that is not performing well on a given time frame the lender might estimate a high risk is associated with recovering the money they might impose higher fees or charges. However, a robust business plan can help you to strike a deal after negotiating it. 

In certain cases, the lender reduces the fees once you have paid a certain amount of such credits or if you have offered credit insurance to do away with the risk of nonpayment by your debtors. You also need to be considerate about the accounting side of your business. A Part of the terms and conditions in such contracts often include ‘with recourse’ and the lender has the right to reclaim the money in case your customers fail to pay it. 

Altogether, invoice discounting can be a very effective process to enhance your business with perpetual cash flow through it. However, take professional advice before entering into any contract.

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