Invoice Discounting: What is it? And How Does It Work? - An Essential Guide for UK Businesses
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For SMEs across the UK, maintaining a healthy cash flow is essential for adaptation and growth and to be able to respond to the funding pressures that present themselves at many stages of their business journey. Invoice Discounting is a hugely popular and flexible financial solution that can boost cashflow and provide funding surety. This guide aims to unpack invoice discounting, outlining its mechanisms, benefits, and considerations, to help you decide if it is the right choice for your business.
What is Invoice Discounting?
Invoice discounting is a way that allows businesses to borrow money against the amounts due from its customers that are currently tied up in outstanding sales invoices. It is a form of short-term borrowing aimed to significantly improve a company’s working capital and cash flow. This solution is particularly beneficial for growing businesses that offer credit payment terms but need cash to flow more readily in order to manage daily operations, keep pace with growth, address turnover spikes or to meet unexpected expenses.
How Does Invoice Discounting Work?
The process of invoice discounting is very straightforward:
- Invoice Generated: Your business generates an invoice to your customer based on the supply of goods or services that you have provided within your normal course of trading.
- Invoice Discounting: You assign the invoice to an invoice financier who will purchase the invoice for an agreed percentage, typically around 80-90% of its value, providing immediate funding to your business.
- Customer Payment: As a business, using this type of solution, you will retain responsibility for their sales ledger, so this means continuing to manage your own credit control and invoice collection processes.
- Balance Receipt: After your customer pays the invoice, the invoice finance provider releases the remaining balance to you, minus their fees and the amount initially advanced.
Key Benefits of Invoice Discounting for UK Businesses
Improved Cash Flow: It provides immediate access to cash that is otherwise tied up in outstanding invoices, thus improving cash flow and access to working capital.
Discretion: Unlike invoice finance, invoice discounting is usually confidential, meaning your customers are unaware of your funding arrangement.
Control: As a business you will maintain control over your sales ledger and retain the relationship that you have built with your customers.
Flexibility: Invoice discounting offers flexibility as the cash made available to your business increases in line with your sales growth, providing incremental funding as you continue to move forward.
Considerations Before Opting for Invoice Discounting
While invoice discounting offers many benefits, as a business it is essential to consider the following before making any long-term commitment:
Eligibility and Cost: Not all businesses are eligible. Invoice financers typically require a robust financial history and a proven record. The cost of an Invoice Discounting facility will vary according to the type of business and nature of the debt “the receivable” being considered for funding.
Customer Relationships: As you will still be responsible for collecting customer payments, you will need to ensure that your business’s credit management processes are strong.
Dependency on Customer Payment: As with all invoice finance type, funding-based solutions, the benefit to your cash flow is contingent on the prompt payment of outstanding invoices by your customers. Overdue payments can have a detrimental impact on the liquidity of your business.
Confidentiality Agreements: Confidentiality agreements, as part of any Invoice Discounting solution often have strict clauses regarding their operation and the obligations of both parties involved. Breaches of these clauses can often lead to penalties, including possible termination of the arrangement.
The Distinction Between Invoice Discounting and Invoice Finance
In the UK, both invoice discounting and invoice finance (factoring) are popular forms of SME funding that allow businesses to monetise their invoices early to boost their cashflow and working capital. Although they serve similar purposes, there are distinct differences in how they operate and the implications that they can have for your business.
Invoice Discounting
Invoice discounting is essentially a funding only type arrangement with a business using its outstanding sales invoices as collateral.
Invoice Finance
Invoice Finance, on the other hand, in addition to providing a funding solution, also includes a full service, outsourced sales administration service.
Key Differences between Invoice Discounting and Invoice Finance
Confidentiality: Invoice discounting is usually confidential, whereas invoice finance is not.
Control of Sales Ledger: With invoice discounting, the business retains control of its sales ledger and credit control function. Under an invoice finance arrangement, the invoice funder has responsibility for the management of the sales ledger, working with the business and ensuring the prompt and efficient collection of outstanding sales invoices.
Customer Interaction: With invoice finance, the funder interacts directly with customers, building its own third-party relationship, in addition to the business, whereas in invoice discounting, the arrangement remains discreet and confidential.
Service Scope: Invoice finance involves the provision of additional added value services such as professional credit control and bespoke debt collection, while invoice discounting provides a funding arrangement only.
Costs and Fees: Both services include fees and interest on the funds borrowed, but the structure may differ. Invoice finance typically includes service fees for ledger management and collection services, while invoice discounting fees are primarily focused on the funding aspect.
While both invoice discounting and invoice finance can empower UK SME businesses by accelerating their access to cash, the choice of solution will depend on the specific needs of the business, how much control they wish to retain over their sales ledger and customer relationships, and whether they require additional cashflow services such as credit management and debt collection.
Conclusion
Invoice discounting can be an extremely valuable cashflow solution for UK SME businesses seeking growth and funding peace of mind.
Reaching out to our eCapital regional teams to understand the full benefits of invoice discounting to your business and how it may fit into your strategic plans and growth ambitions is highly recommended.
eCapital UK
eCapital Commercial Finance (eCapital) is a leading invoice financier providing funding facilities up to £5m to support the growth of SMEs through the provision of flexible working capital facilities. With five fully functional UK regional offices, its local teams are uniquely placed to respond promptly and purposefully to the cashflow needs of its clients. The business has grown significantly since its launch in 2001, providing over £4 billion of funding to businesses. It is majority owned by eCapital, a US based financial services business with interests in the USA and Canada.
