As a business owner you maybe looking at a finance product called invoice discounting but are unsure of its advantages or disadvantages it may provide.
Businesses often find themselves running short of working capital though no fault of their own, Invoice Discounting maybe the solution.
The constant churn of their invoicing cycles places a high demand on on the cash flow position as a result fall short in their cash balances. Business owner to get cash flowing into their company, one way maybe to get a quick business loan, this can be achieved by the use of invoice Discounting by submitting cleared invoices as collateral.
This type of finance is fast becoming a popular method of raising fast cash for small businesses, it is important to understand the advantages and disadvantages of invoice discounting before you borrow on credit.
For certain types of business, invoice discounting can bring many different benefits, a positive cash flow position namely one of those. I this article we carefully look at the pro’s and con’s this type of invoice finance brings to a business.
Invoice Discounting Key Advantages and Disadvantages
Here are the advantages and disadvantages of invoice discounting:
Advantages of Invoice Discounting
1. Increased Cash Flow
The overall major advantage to invoice discounting is the increased cash flow is achieved by its use, providers of this service generally work much faster than banks in assessing the viability of the lender. Many discounters are able to realise large amounts of cash from your commercial invoices in as little as 48 hours meaning discounting has significant speed advantages over traditional finance.
2. Working Capital Cycle is Speeded Up
The companies unpaid invoices are freed up quickly using discounting, it allow liquidity within the business and keeps they cashflow turnover positive as well as reducing the working capital cycle turn time.
It is useful for businesses who have a smaller number of clients, if these clients pay larger value invoices, it allows a larger spread of the sales ledger concentration, if one of these customers is late in paying it could pose risk to the overall financial health of the company
3. No Need for Clients to Know
As invoice discounting is on a confidential basis, which is in contract to invoice factoring, your clients will not know you use an invoice finance provider to fund your unpaid invoices.
Sometimes business are worried that is they disclose the use of a factor it may show unfavourable financial confidence in their brand.
4. Business Retains in Control
With discounting, you remain in control of all financial affairs and its accounts receivables role. The business will continue to collect payments and chase outstanding invoices, the business relationship between the company and their customer is not altered in anyway with this type of finance.
5. Interest is Only Paid on the Money you Borrow
In comparison to factoring, which imposes stricter interest on money borrowed. Businesses why use invoice discounting therefore find its costs as effective as an overdraft and a great costs saving over other forms of business finance.
6. Earlier Paying of Suppliers
Many businesses are throttled by a restricted liquidity, in which they end up paying their own supplies late, as invoice discounting realises liquid cash and improved cash flow once an invoice has been raised, it is easier to pay suppliers faster, this allows the negotiate of a early payment discount as a result
7. Bad Debt Protection
Bad debt protection is offered as a free add on with some invoice discounting lenders, this will ensure you are paid in full should your customer becomes insolvent.
8. Working Capital Available for Expansion
Businesses use invoice discounting as a strategically way of increasing working capital so the company can fuel its growth or purchase another business.
9. Short Turnaround Time
Unlike business loans, invoice discounting is the fastest way to get a business loan. Facilities can be in place within seven working days. The short turnaround time helps businesses that require cash quickly in order to pay its outstanding liabilities to creditors.
Disadvantages of Invoice Discounting
1. Obtain Credit on Small Companies maybe Difficult
Most invoice discounting providers require a substantial turnover of about £500,000 per year, as such this form of finance has a disadvantage to smaller enterprises that may find it difficult to find lenders willing to accept them.
Companies wishing to use this type of invoice financing must must be able to demonstrate an established track record as well as having an in-house credit collections team. new alternative lenders are appearing within the market to fill this gap, these type of lenders may charge a higher fee as a result
2. Higher cost of Borrowing
As invoice discounting basically is a short-term loan offering, this type of finance usually comes with high costs, these tend to be higher than traditional bank loans.
3. Reliant on Invoice Discounting
Whilst the business goal is to manage a positive cash flow with the overall success of the business in mind, it is also possible for businesses to become trapped in a debt cycle. The business becomes reliant on invoice discounting, and if financial unable to operate without the existence of this monthly cash flow arrangement.
4. Obtaining Additional Business Finance Harder
Once Invoice discounting is in place as debenture is placed on your company, some lenders may not like to be second in line so this may have an effect on obtaining further business finance.
5. Your customers must be other businesses
Invoice discounting is only available on commercial invoices, this means your customer must be another business. Should your trade be the sale of products or services to the general public then this form of finance will not be available to you.
6. Contract Length
The contract length that you maybe tied in for with invoice discounting could be up to twelve months. Most invoice discounting companies will require a minimum contract length then followed by a short notice period of one month.
Also Read: Difference Between Invoice Discounting and Invoice Factoring
Frequently asked questions
What are the advantages of invoice discounting?
One of the main advantages of invoice discounting is that it provides companies with immediate cash flow, which can be used for working capital, inventory purchases, or other business needs. It also helps companies to avoid late payments and bad debts by transferring the risk of non-payment to the finance company. Additionally, invoice discounting can be a flexible financing option, as companies can choose which invoices to sell and how much of the invoice amount to receive upfront, depending on their cash flow needs.
What are the disadvantages of invoice discounting?
One of the main disadvantages of invoice discounting is that it can be more expensive than other financing options, such as bank loans or lines of credit, as the finance company charges a discount fee and other fees for their services. Additionally, invoice discounting can be a less discreet financing option, as the finance company may contact the company's customers to collect the invoice amount, which could damage the company's relationship with its customers. Moreover, invoice discounting may not be available for all types of invoices, as some finance companies may have restrictions on the types of invoices they accept, such as invoices with long payment terms or high-risk customers.
Conclusion
Invoice discounting is a financing option that allows businesses to improve their cash flow by selling their outstanding invoices to a third-party finance company. This financing method comes with both advantages and disadvantages. The main advantage of invoice discounting is that it provides companies with immediate access to cash, which can be used to cover immediate expenses and meet financial obligations. It also offers greater flexibility than traditional bank loans, as companies can choose which invoices to sell and how much of the invoice amount to receive upfront.
However, one of the main disadvantages of invoice discounting is that it can be more expensive than other forms of financing, as finance companies charge a discount fee and other fees for their services. Additionally, invoice discounting can damage relationships with customers, as finance companies may contact them to collect the invoice amount, which can cause inconvenience and mistrust.
In conclusion, while invoice discounting can be a useful financing option, businesses must weigh the pros and cons carefully before deciding whether it is the right choice for them.
Seasoned professional with a strong passion for the world of business finance. With over twenty years of dedicated experience in the field, my journey into the world of business finance began with a relentless curiosity for understanding the intricate workings of financial systems.