What is invoice discounting?

Updated in July 2023

Invoice discounting is an invoice finance facility that businesses use to leverage the value of their sales ledger and get an advance on outstanding invoices. An invoice discounting facility allows businesses to use their outstanding invoices as collateral – to get an advance on the partial or total invoice value. This form of invoice financing can boost your cash flow by enabling you to access up to 100% of your receivables. 

Invoice discounting is the most simple way of using invoice financing, where you have control over collecting payments from your customers. The invoice discounting provider, or the lender, only provides the cash advance. Once the cash is in your account, minus a service and borrowing fee, your company handles the credit control and payroll as usual. 

The reality of business operations is that some companies find themselves waiting 30, 60, or even 90 days to receive payment from customers. This delay can create gaps in cashflow that can unsettle the balance sheet. Invoice discounting companies offer a timely solution to this issue, enabling you to access your receivables much sooner. 

How Does an Invoice Discounting Facility Work? 

As a business owner your operations continue as usual, engaging with customers and reaching agreements. Once a deal is struck and an invoice is raised, the next step involves your invoice finance provider – in this case, the invoice discounting company. Upon presenting your outstanding invoice to the invoice finance company, you can get an advance up to 100% of your invoice value as soon as the transaction is validated, and your timesheet is cleared. 

When you opt for invoice discounting, you can expect quick access to your funds. Once your invoice is validated, typically within 24 hours, the cash you’re owed becomes available to you. But what about collecting payment from your clients? With an invoice discounting arrangement, you retain the responsibility of pursuing your customers for payment of the outstanding invoices. 

One crucial aspect of managing an invoice discounting facility is credit control. As you handle your own collections, the time it takes for your client to settle their invoice directly impacts the borrowing fee you incur. The longer the payment takes, the higher the fee. However, please note that invoice discounting rates are often lower than invoice factoring. This difference is due to the hands-on approach you take in managing the collection process in an invoice discounting setup. 

In essence, an invoice discounting facility offers a valuable financial tool to boost your cash flow while maintaining direct control over customer relationships and credit control. It provides a flexible and straightforward solution for businesses that prefer managing their own receivables while benefiting from the immediate cash flow that invoice finance provides. 

Invoice finance use cases 

• Recruitment Businesses with High Payroll Expenses: A growing recruitment agency places temporary workers and contractors with clients who have payment terms of 30-60 days. As a result, the agency must cover the payroll expenses for these workers long before receiving payment from clients. Invoice finance enables the agency to access funds from their outstanding invoices, ensuring they can pay their temporary staff on time and maintain a reliable workforce without straining their cash flow.
• Cash Flow Management: Small and medium-sized businesses often face cash flow challenges due to delayed payments from clients. Invoice finance allows businesses to access immediate cash by selling their unpaid invoices to a finance provider. This helps them maintain a healthy cash flow and meet their financial obligations, such as paying employees, suppliers, or investing in growth opportunities. 
• Business Expansion: When businesses experience rapid growth or expansion, they may face a strain on their working capital. Invoice finance can provide the necessary funds to support expansion plans, such as hiring new staff, purchasing additional inventory or equipment, or opening new locations. By unlocking the value of outstanding invoices, businesses can seize growth opportunities without waiting for payment from customers. 

• Seasonal Businesses: Many businesses operate in seasonal industries where demand fluctuates throughout the year. For example, a retailer might experience a surge in sales during the holiday season but face slower periods afterward. Invoice finance enables these businesses to bridge the cash flow gap during the off-peak season by converting their outstanding invoices into immediate working capital.
• Supplier Negotiations: Invoice finance can be used strategically in supplier negotiations. Businesses can negotiate better terms with their suppliers by offering early payment in exchange for discounts or other benefits. By accessing funds through invoice finance, businesses can take advantage of these opportunities and potentially improve their profitability.
• Startups and SMEs: Startups and small-to-medium-sized enterprises (SMEs) often struggle to secure traditional financing due to their limited operating history or lack of collateral. Invoice finance offers an alternative funding option for these businesses, leveraging their accounts receivable as collateral. This allows startups and SMEs to access capital quickly and efficiently, supporting their growth and stability.
• Debt Management: Some businesses may face challenges with outstanding debts or loan repayments. Invoice finance can provide a means to manage and pay off existing debts. By converting unpaid invoices into immediate cash, businesses can settle outstanding obligations, reduce their debt burden, and improve their financial position. 

The Benefits of Invoice Discounting 

Advantages of invoice discounting  

1. Quick Access to Funds: Invoice discounting can provide an immediate cash, which can amount to a substantial portion of the outstanding invoice value, thereby greatly enhancing your cash flow management.  
2. Eliminating Payment Collection Hassles: Invoice discounting can transfer the burden of chasing invoice payments to your finance provider, freeing up your time and energy to focus on running your business. In effect, this means you can obtain your funds without having to wait for the typical 30 to 90-day repayment period to end. 
3. Versatile Use of Funds: The cash received from an invoice discounting arrangement can be used to achieve a variety of business goals. These could range from boosting working capital, reducing debts, funding expansion, hiring new staff, or procuring stock and equipment. 
4. Mitigating Business Risks: Particularly for smaller businesses, late payments of large invoices can pose significant risks. Invoice discounting can alleviate this concern by ensuring you receive most of the invoice value immediately, thereby stabilising your financial status. 
5. Maintaining Client Confidentiality: With invoice discounting, there’s no legal requirement to inform your clients about the arrangement. This means you can keep your financial strategy private. 
6. Prompt Payment of Your Obligations: The improved cash flow provided by invoice discounting can facilitate quicker repayment of your own debts or invoices. This could potentially unlock discounts for early repayments, further bolstering your financial position. 
7. Bad Debt Protection: Some invoice discounting arrangements offer ‘non-recourse’ finance, where the lender assumes the responsibility for unpaid invoices. This means you would still receive the full amount you owe, minus the lender’s usual fee, even if the customer fails to pay entirely. 

The potential drawbacks of invoice discounting  

Invoice discounting can help businesses reduce cashflow problems to get ahead and grow. However, it is important to consider the potential drawbacks associated with it. One significant drawback could be the cost involved. While invoice discounting provides quick access to capital, the financier charges a discount or fee for advancing the funds. If this fee is substantial, it and can erode the profitability of your business. Additionally, businesses may face challenges if the customer fails to pay the invoice. In such cases, if you are not covered by Bad Debt Protection, your business remains liable for the amount advanced by the financier, which can create a financial burden. Moreover, invoice discounting requires a level of transparency and sharing of financial information with the financier, which some businesses may find uncomfortable. This loss of control over the billing and collection process can strain the customer relationships if the financier’s collection practices are not aligned with the business’s values. 

Invoice Discounting vs. Invoice Factoring 

At its core, invoice discounting is the most straightforward form of invoice finance. You utilize your outstanding invoices as collateral to gain a cash advance on the payments owed to you. Once you secure this advance, the responsibility of collecting payment from outstanding debtors remains yours. 

On the other hand, invoice factoring shares a similar principle, where your unpaid invoices serve as collateral for an instant cash boost. The key difference lies in the management of your sales ledger, which, in this case, is transferred to the lender. The lender then assumes the task of collecting payment. 

When comparing invoice discounting and invoice factoring, you’ll find that you have more credit control with an invoice discounting facility. The process is simpler – you obtain an advance on the invoice amount in exchange for a fee and continue managing your payment terms and collections. 

The cost structure of invoice discounting and invoice factoring also differs significantly. Generally, invoice discounting tends to be more cost-effective as the company retains the collection process, eliminating the need for outsourcing. On the other hand, invoice factoring typically incurs higher costs due to the lender providing additional services, like taking care of receivables and managing the credit control process. 

What Is Non-Recourse Invoice Discounting? 

Non-recourse invoice discounting is a used by businesses to mitigate the risk associated with non-paying customers. When you opt for a non-recourse agreement with your finance company or lender, you agree to pay a slightly higher fee. The advantage, though, is that the lender assumes the liability in the event of an unpaid invoice. This arrangement provides you with an extra layer of financial security, as it transfers the risk of non-payment from you to the lender. 

What about recourse invoice discounting? This is another option available in the world of invoice financing. In a recourse invoice discounting setup, your business retains full responsibility for any outstanding invoices. If a customer fails to pay, you are obligated to return any cash advances received from the lender. 

So, how does invoice discounting work in these scenarios? Essentially, you’re leveraging your unpaid invoices to get an advance from the lender. The critical difference lies in who takes on the risk of non-payment. With non-recourse invoice discounting, the lender bears this risk. With recourse invoice discounting, it’s on the business owner. In general, it’s good to consider bad debt protection to give you peace of mind. Many financiers offer it, albeit at various levels. At Sonovate, we offer 95% bad debt protection as standard.  

What Are the Costs of Invoice Discounting? 

The expense associated with invoice discounting can vary significantly, as it is dependent on the specifics of the business and the individual invoices involved. There are typically two fees that make up the cost of invoice discounting: the service fee and the borrowing fee. 

Understanding invoice discounting fees: The service fee is typically calculated as a percentage of your turnover. Invoice discounting also entails an additional charge known as the borrowing fee. This is charged per invoice and is comparable to interest. 

Understanding borrowing fees: The longer it takes for you to collect the payment, the higher your borrowing fee will be. Therefore, it’s difficult to pinpoint what the exact costs of invoice discounting will be for each company. 

However, since you are collecting and managing the outstanding debt yourself, invoice discounting fees are typically cheaper than invoice factoring fees. 

Invoice Financing FAQs: 

What are the advantages of using invoice financing for small businesses? 

Invoice discounting offers the benefit of allowing you to manage your outstanding debt or unpaid invoices yourself, meaning you maintain credit control. As a result, the fees related to an invoice discounting facility provided by an invoice discounting company or other finance company tend to be lower than those associated with invoice factoring. 

What should businesses consider when thinking about invoice financing?  

When considering finance options and trying to improve cash flow by leveraging receivables, businesses might find that the confidentiality and credit control associated with invoice discounting make it a favourable choice. This is particularly true if they have the capability and resources to manage their unpaid invoices effectively. As with all financial decisions, it’s essential to consider the specifics of your business and your outstanding invoice situation before deciding on the best approach. 

Does the duration of payment collection affect the borrowing fee?  

The answer is yes. The longer the time taken to gather the payment, the higher the borrowing fee. Consequently, it’s hard to provide a one-size-fits-all figure for the costs of invoice discounting for every business. 

Is Your Business Eligible For Invoice Financing? 

It’s important to note that eligibility criteria can vary among invoice financing providers, and they may have additional requirements specific to their services. It’s advisable to consult with different providers to understand their specific criteria and determine which option best suits your recruitment business’s needs. 

1. Established Business: Typically, traditional invoice financing providers prefer to work with businesses that have a track record of operating for a certain period, often six months to a year. This helps establish the stability and reliability of the business. In such cases, many alternative providers offer better options for newer businesses, looking more closely at your plan and your clients toextend a facility that helps you get started in the market.
2. B2B or B2G Invoices: Invoice financing is generally available for businesses that primarily operate in the business-to-business (B2B) or business-to-government (B2G) sectors. The invoices must be payable by reputable commercial or government entities.
3. The Creditworthiness of Your Clients. Thecreditworthiness of the recruitment business’s clients is an essential consideration. Invoice financing providers want to ensure that the businesses that owe money to the recruitment company have a history of paying their debts on time. This reduces the risk associated with the financing.
4. Invoice Quality: The quality of the invoices themselves is important. They should be properly documented, accurate, and not subject to disputes or potential legal issues. Invoices that are clear, complete, and include all necessary information are more likely to be eligible for financing.
5. Minimum Invoice Amount: Some invoice financing providers may have a minimum threshold for the invoice amount that they will consider. This helps ensure that the cost of financing remains reasonable and viable for both parties. Again, this is more typical of traditional lenders such as banks. Alternative providers like Sonovate do not typically impose such restrictions.
6. Absence of Liens or Encumbrances: The invoices should not be subject to any existing liens or encumbrances. This means that the recruitment business must have clear ownership of the receivables and not have assigned them as collateral to any other party.
7. Profitability and Financial Stability: While invoice financing does not typically require extensive financial documentation or collateral beyond the invoices themselves, some providers may consider the overall financial stability and profitability of the recruitment business.

Why Sonovate?

Whereas most funders offer 80%, Sonovate customers can raise money for up to 100% of the value of their invoices to accelerate cash flow and plug the gaps between paying contingent labour and receiving payments. Unlike traditional lenders, we do not impose concentration limits on you, so you are free to grow with your best clients. We also offer 95% Bad-Debt Protection as standard to give you peace of mind. 

This is achieved through our industry-leading technology platform with a selection of solutions as well as comprehensive support from our team of experts. Depending on which Sonovate option you select, we’ll pay you on the same day, the following day or on a weekly basis. You can choose a CHOCC option where you collect payments from your clients, or we can do the collections on your behalf and wait  wait for your clients to pay us back while you make the most of your cash. Our state of the art platform offers transparent pricing, so you will know exactly how much you’re charged against each invoice. Those rates depend on your clients’ credit worthiness, the countries you’d like payments to be made to and other such factors. 

How do I transfer from my existing invoice discounting provider? 

Review your current agreement: when your current facility or debenture is due to expire is an ideal time to review your existing invoice discounting arrangements. To make sure you have the best service in place, there are a few questions to ask: 

• Invoice discounting vs Invoice factoring: Do you need invoice discounting or do you prefer an invoice factoring option where the lender will chase payments.  
• Do you need more funding or greater flexibility? Perhaps your business has outgrown the facility you first put in place. 
• Are concentration limits holding you back? You may have opportunities to grow that you can’t currently take advantage of. 
• Do you need better export financing options? International opportunities are plentiful at the moment. Do you have the right funding to move cross borders? 
• Would you like simpler, more transparent pricing? Perhaps you have been unpleasantly surprised by hidden costs. 
• Are you tied down by complex covenants? Do you feel there must be a simpler way? 
• Do you feel technology is holding you back? Maybe you could achieve operational efficiencies with a more sophisticated, integrated IT solution. 
• Is your facility tailored to your industry? Do you often find yourself having to retro-fit your business decisions to suit a one size fits all funding contract? 
• Research Alternative Providers: Research and evaluate alternative invoice discounting providers to find one that better suits your needs. Consider factors such as their reputation, customer reviews, fees, terms, and any additional services they offer. 

Contact Potential Providers: Reach out to the potential invoice discounting providers you’ve identified as suitable replacements. Share information about your business, your current invoice discounting arrangement, and your requirements for the new provider. 

Discuss Terms and Conditions: Engage in detailed discussions with the new providers to understand their terms, fees, and any specific requirements they have. Ensure that their services align with your business’s needs and goals. 

Due Diligence: Perform due diligence on the new provider, including assessing their financial stability, customer support, and reputation in the industry. Request references or case studies from other clients if necessary. 

Negotiate and Finalize the Agreement: Once you’ve selected a new invoice discounting provider, negotiate the terms and conditions to ensure they are favorable for your business. Pay attention to any differences in fees, advance rates, recourse policies, and contract duration. 

Notify Your Current Provider: Once you’ve reached an agreement with the new provider, notify your current invoice discounting provider of your intention to terminate the existing arrangement. Follow the notice period and termination procedures specified in your current agreement. 

Transfer Process: Work closely with your new provider to facilitate the transfer process. This may involve providing them with necessary documentation, such as customer details, outstanding invoices, and any relevant financial information. 

Inform Your Clients: Notify your clients about the change in your invoice discounting provider. Provide them with updated contact information and any instructions they may need to update their payment processes. 

Transition and Set Up: Coordinate with the new provider to ensure a smooth transition. Set up any required systems, such as invoice submission and verification processes, so that your business can seamlessly continue its operations.