What is invoice discounting?
Invoice discounting is probably the simplest form of invoice finance. As with all types of invoice finance, with invoice discounting you sell unpaid invoices to a lender and they give you a cash advance that’s a percentage of the invoice’s value. Once your customer has paid the invoice, the lender pays you the remaining balance minus their fee.
Another way to look at discounting is that it’s a series of short-term business loans using invoices as security. In other words, the lender knows that you’re owed the money, so will lend you most of it before your customer has actually paid you.
Invoice discounting is normally confidential (it's sometimes called 'confidential invoice discounting'), and you’ll continue to deal with customers yourself as normal — your customers won’t know you’re using a finance provider. The downside to this is that you’ll still have to chase invoices yourself, unlike invoice factoring.
Invoice discounting example
Joe’s Business has just started a discounting facility with The Invoice Company to help with cashflow, and Joe issues an invoice to his customer worth £10,000 for work he’s already completed. Joe’s agreement with The Invoice Company states that the advance percentage (also known as 'initial percentage' or 'prepayment percentage') is 75% — that means Joe is advanced £7,500 by The Invoice Company as soon as the invoice is raised.
Generally, Joe would upload the invoice to his online account with the lender and then received the advance.
Joe’s customer settles the invoice a few weeks later, paying £10,000 into a trust account controlled by the lender. With confidential facilities, from the customer’s point of view it will look like they’re paying Joe directly.
The Invoice Company then pays Joe the remaining £2,500, minus their fees. The fees would typically be around £250-300, so Joe would receive between £2,250 and £2,200 in this example.
This is a basic example, but the same principle can be applied to invoice discounting across the whole sales ledger. Of course, there are sometimes more specific terms and conditions than the above, like maximum accounts receivable, minimum period, maximum overdue accounts, and so on — see the main page on invoice finance for more details on the common terms.