When a company requests for a loan by keeping its unpaid
account receivables as collateral, the process refers to invoice discounting.
In this type of financing, the financer can alter the amount of the debt as
soon as the amount of accounts receivables, kept as collateral, changes; hence
the form of the loan offered is also short term.
Also considered as debtor finance, invoice discounting eyes
to benefit companies having cash flow problems, as their debtors are expected
to pay invoices not before 30 to 90 days. If a company is facing problems with
their financial reserves being insufficient to pay corporate expenses, allowing
clients to pay in 30-90 days can affect the cash flow of the business. With
invoice discounting, instead of waiting for customers to pay within the normal
credit terms, companies receive the cash as soon as the invoice is issued;
thereby getting an accelerated cash flow from the customers.
Financer usually tend to offer loans of a smaller amount
than the amount of the account receivable kept as collateral. Usually the
amount is 80% of the total invoices, which are less than 90 days old. Through
invoice discounting, the financier providing the short-term loan is benefitted
from both the interest rates on the loan and a monthly charge for maintaining
the arrangement.
With invoice discounting, the companies always have a power
to retain control over its sales ledger and the payments are cased in the usual
way. There are also direct payments from the clients and no third party is
involved.
Invoice discounting can be beneficial for any company which
provides product or service to clients and allows a credit term of 30-90 days.
However, businesses which are mostly
benefited with invoice discounting are:
●
Construction
●
Recruitment
●
Manufacturing
●
Wholesalers
●
Printers
●
Couriers
How invoice discounting works:
●
Companies provide
goods and services to customers and make an invoice
●
Details of invoices are sent to the financer
●
Financer provides the
funds based on the amount of the invoices, usually within 48 hours
●
Companies gets back
the balance of the invoice once the debtor pays back
Advantages of invoice discounting:
●
Companies can release
up to 80 percent of outstanding invoices
within 24 hours
●
Invoice discounting is
much simpler than other business loans
●
No assets are put on
risk
●
Quicker and faster
method to procure cash than applying for a Cash Credit
●
Cash flow from the
customer is considerably improved
●
Business relations between
the seller and buyer remain unaffected
●
Companies get to
choose to grow sales in terms of cash or credit
●
Companies continues to
get the control over sales receivables
●
Financial agreement
between companies and financers is not disclosed to buyers and confidentiality
is maintained
●
Companies’ power to
negotiate over discounts enhances with seller’s invoice
●
Financers provide
companies with excellent business guidance
Disadvantages of invoice discounting
●
Companies’ profit
margin decreases as fee charged by the financer is an additional cost
●
Financers allow
borrowing only on commercial invoices
●
Focus on strengthening
credit norms for debtors can be affected with excessive usage of invoice discounting
●
Invoice discounting
can negatively affect the financial statements of new businesses
●
Amount of loan
extended is highly volatile
Key features of invoice discounting
●
Perfect alternative
solution for traditional business form
●
Cash flow remains
unaffected as instant cash is provided over cash tied up with unpaid invoices
●
Companies retain
control on collection of payments
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