How does invoice discounting work?

Invoice discounting is an ideal way to increase cash flow by speeding up payments from outstanding invoices.

Questions often asked include;

What is invoice discounting?

It is a type of invoice finance offered to companies who want raise finance secured on their sales ledger.

Invoice discounting is a way to gain access to money owed to your business from unpaid invoices.

Unpaid invoices are “sold” to a specialist lender, who provides you with a portion of the total amount of invoices sent to clients.

How much the lender will finance per invoice varies, however most will finance up to 90% of the total invoice amount.

Discounting is similar to invoice factoring, however the main difference is that you still remain in control of your sales ledger and therefore debts. Because of this, fees tend to be lower.

SMEs are currently chasing £50 billion in late payments from outstanding invoices.

Oliver Prill, Tide's chief executive, said: “It is, however, shocking to see exactly how much time SMEs, and particularly the self-employed, are wasting by having to chase clients to pay promptly. Cash flow is crucial for SMEs, and just a few late payments can tip them into danger of becoming insolvent.” [source]

Much of this cash could be released using invoice discounting.

What are the benefits of invoice discounting?

  • Financial stability - Having a reliable and consistent source of cash flow will have numerous positive effects on your business
  • Timely payments - Invoice facilities take out the uncertainty of not knowing when you will be paid
  • Retaining control - You are still in charge of your sales ledger, so you know exactly where you stand
  • Low cost funding - Fees can be lower in relation to the cost of lump sum business loans depending on your company and credit status

The main benefit of invoice discounting is being paid faster without having to wait for clients to pay their invoices.

In addition to you will only need to pay fees for the money that you actually borrow and not the total facility allowance.

How does invoice discounting work?

You will raise an invoice to your lender once issued to the debtor and they will process this within 48 hours of receipt. Then depending on your facility type, when the invoice has been paid, they will provide you with the rest minus their fee.

how invoice discounting works

How much does invoice discounting cost?

There are two set of fees involved, discount fees and service fees.

Discount fees are percentage based and are calculated from the total invoice amount and (usually) the time it takes for your client to pay. The quicker the client pays the lower the fee.

Fees usually range from 0.2% to 5%, however these do vary between lenders.

Service fees are also percentage based and calculated from your total annual turnover. Fees usually range from 0.75% to 2.5%.

It is worth noting that fees do vary between lenders and finding the best one for your business needs is of paramount importance.

How do you get paid?

With an invoice discounting facility in place, you still send your clients invoices directly as well as the lender.

Once the lender receives the invoice, they will pay you up to 90% of the invoice amount.

When your client pays the invoice, you receive the paid amount less the amount already financed by your lender, as well their fee. In general fees range from 0.2% to 0.5%

For example, you send a client an invoice for £20,000, you have a facility in place for 90% of invoices and a fee of 0.2%.

The lender will deposit £18,000 in your bank account in as little as 24 hours of receiving the invoice.

When the client pays the invoice, you retain the remaining 10%, £2,000 less the lenders fee of £400 and pay back the lender what you owe. If you are using disclosed invoice discounting, then the lender will be paid directly by the client. The lender will then pay you what you are owed.

This leave you with a total payment of £19,600.

Overall, the benefit of receiving payments of invoices, without having to wait up to 60 days for payment has cost £400.

£400 is a small amount compared to the negative impact of not being paid £20,000 on time. 

Will your clients know you are using invoice discounting?

Whether your clients are aware of you using invoice finance depends on which type of facility you take out.

There are two main options available to you, confidential or disclosed. Confidential discounting tends to be cheaper then discounted due to reduced admin and paperwork for the lender.

When using confidential invoice discounting your clients will pay you their invoice directly and you are then responsible for paying back the lender what you owe.

Confidential discounting means that your clients will not know you are using a facility to fund slow playing invoices.

With disclosed invoice discounting, your clients are aware of the facility being in place as they will pay invoices directly to the lender, who will then in turn pay you the outstanding balance.

As the lender will be processing invoices and payments, fees tend to be higher due to the increased amount of admin and paperwork.

Disclosed facilities tend to be easier to get as lenders see less perceived risk of none payments as they are paid directly from clients.

Whether you use confidential or disclosed discounting you are still responsible for processing and chasing unpaid invoices.

Lenders will not do this on your behalf, unlike invoice factoring where lenders will carry out the leg work for you.

What is involved in applying for invoice discounting?

  • We can lend to any trading business that invoices on a business to business basis (B2B)
  • You must have a minimum turnover of £100,000 per annum and take a minimum facility of £25,000
  • There is no maximum

When you sign up to an Invoice Finance provider, they will take a first charge debenture over the book debt in the business.

You will raise an invoice to them once issued to the debtor and they will process this within 48 hours of receipt.

Then depending on your facility type, when the invoice has been paid, they will provide you with the rest minus their fee.

You will have a dedicated account manager that will work closely with you and support your business in this transition.

They provide you with an online portal where you can upload your invoices and drawdown on all funds.

Other invoice finance options

If invoice discounting does not suit your needs, there are several other options available to you.

  • Invoice Factoring - This is like discounting however the lender will carry out invoice administration and chase any outstanding invoices
  • Selective Invoice Finance - This is where you can select specific invoices to have Factored to raise capital, the repayment works the same as a standard invoice finance facility
  • Spot Factoring - You choose one large invoice usually upwards of £50,000 as security to raise capital for the business
Updated: August 08, 2020