What is Invoice Discounting (Invoice Financing)?

Invoice discounting is a way of quickly raising cash by borrowing against unpaid invoices.

Normally, you invoice a customer and give them a number of days’ credit. But with invoice discounting, instead of waiting for them to pay, you go to a lender and use the invoice as collateral to borrow cash.

A lender will typically give you 80%-85% of the value of an invoice immediately and you’ll get the remainder when they receive the total value of the invoice plus any fees or interest you agreed to pay.

Invoice discounting is a bit different from “factoring” because it usually occurs on an invoice-by-invoice basis. Factoring usually involves a 3rd party taking over your entire sales ledger, fronting you the cash and collecting invoices on your behalf.

Invoice discounting

When to Use Invoice Discounting

Invoice discounting is most useful for growing businesses, seasonal businesses and struggling businesses.

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Growing Businesses

As businesses grow they often take on bigger and bigger customers who demand ever-longer payment terms. So business can be booming but cash gets tighter and tighter. Invoice discounting can unlock the cash needed to fund the next big order or investment.

Case Study – Primal Pantry

The Primal Pantry is a fast-growing business manufacturing a range of healthy snacks and protein bars. They have contracts with the UK’s leading supermarkets who have payment terms of 60+ days.

A growing business in this position is at risk of overtrading. So they approached invoice discounting company, GapCap, to help free up the cash locked up in these invoices. This has allowed The Primal Pantry go from strength to strength and helped fund significant international expansion.

Seasonal Businesses

Seasonal businesses can face huge pressures on their cash flow at certain times of the year. A loan isn’t always an appropriate response to specific pinch points like this. Invoice discounting, however, can be a flexible way of smoothing the ride for a few months.

Case Study – An Event Services Company

Another client of GapCap’s is a company that provides temporary staff to events and functions. Every year the summer is peak season for them. However, their clients demand long credit terms during which the company has to pay their staff.

GapCap financed all the invoices from one of the company’s clients. It meant the business didn’t have to wait until the Autumn to get paid. And this, in turn, allowed them to grow their business during a peak period.

Struggling Businesses

Businesses struggling under cash flow stress often face a Catch 22; they need to invest to generate more cash, but they need cash in order to invest. Invoice discounting can unlock pockets of cash to make investments that support a programme of continuous improvement.

Case Study – The London Lions

Also a client of GapCap’s, this professional basketball team found themselves sandwiched between lengthy payment terms and increasing costs, primarily salary demands. Invoice financing unlocked the cash to invest into new marketing initiatives with very positive results.

 

Pros

  • You’ll receive an injection of cash at a competitive interest rate
  • You maintain control over your sales ledger (unlike with invoice factoring)
  • You don’t have to own any assets to qualify
  • The amount you can borrow grows with your business, meaning no need to extend an overdraft or reapply for a loan

Cons

  • You will lose some profit from orders or services you provide
  • Financiers will usually only discount commercial invoices, so if you sell to the public you won’t be eligible
  • You will need to demonstrate a robust process for collecting payments
  • It is possible to become over-dependent on invoice discounting, meaning you can’t leave without it negatively impacting your operations

Are you looking to forecast when you might need a cash injection? Check out Float Cash Flow Forecasting!

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Ewan McCowen

I'm a marketing professional and Babson alum who loves all things business. When not in the office you might find me somewhere in the Scottish Highlands, fishing or wild camping.