Invoice discounting, also known as invoice financing, is a financing method that allows businesses to use their unpaid invoices as security for a loan. In this type of financing, the ownership of the sales ledger debts remains with the business owner, but they use the unpaid invoices as security to obtain a loan. The invoice financing provider usually provides a percentage of the invoice’s value as a loan.
The responsibility for collecting the debts remains with the business owner, and they will continue to chase their debtors for payment – this can be a good thing, do you really want someone else who doesn’t work in your business chasing your debts? However, the invoice financing provider may offer additional services, such as credit control and debt insurance, for an extra fee. This can be beneficial for small businesses that do not have the resources to manage these tasks themselves or want to reduce the risk of bad debts.
To secure the loan, the invoice discounter will take security over the invoices, which means they can claim the amount owed by the debtor direct, after only the costs of collection, if the business owner fails to repay the loan. The invoice financing provider will typically require a debenture over the business, which normally gives them security over all the assets of the company. This can include stock, equipment, and other assets, which can be used to repay the loan if the business fails to repay it.
The cost of invoice discounting can vary depending on the provider and the level of service required. Typically, the cost is calculated as a percentage of the invoice value, and it can range from 0.5% to 5% per month, depending on the size of the loan and the level of service provided.
It is essential to be aware of the potential risks and costs associated with invoice financing before committing to it – invoice discounting is often perceived as a source of funding for the desperate. Often the agreement comes with a personal guarantee, with all the risks that involves. For these reasons it’s a good adea to seeking the right advice at the right time so that you fully understand the terms and conditions of the discounting agreement and risks involved.