What is Invoice Discounting? Its Benefits & More

Let’s understand what is invoice discounting.

Invoice discounting is a financing option where a business sells its unpaid invoices to a third-party financial company at a discount in exchange for immediate cash. The third-party company then collects the full payment from the customer and keeps a fee for their services. This allows the business to access cash more quickly and improve their cash flow.

How Does Invoice Discounting Works?

To understand what is Invoice discounting, it’s important to know how invoice discounting works.

Invoice discounting is a financing arrangement in which a business sells its unpaid invoices to a third-party financial company, known as a factor, at a discount. Here’s how it works:

1. A business provides goods or services to its customers and issues an invoice for payment.
2. The business then sells the invoice to a factor, which typically pays the business a percentage of the invoice value upfront, typically around 70-90%.
3. The factor then takes over the responsibility of collecting payment from the customer when the invoice is due, typically within 30-90 days.
4. Once the customer pays the invoice, the factor deducts its fee and returns the balance to the business.

The factor charges a fee for its services, which is typically a percentage of the invoice value or a percentage of the amount advanced to the business upfront. The exact fee varies depending on factors such as the creditworthiness of the business and its customers, the industry, and the size of the invoices.

Invoice discounting is often confidential, which means that the customer is not notified that the invoice has been sold to a factor. This allows the business to maintain its relationship with its customer and continue to handle all other aspects of the transaction, such as shipping and customer service.

Invoice discounting can provide a business with immediate cash flow to cover operational expenses, without waiting for payment from customers. It can also help businesses manage their cash flow more effectively and reduce the risk of bad debts. However, it can be an expensive form of financing, and businesses should carefully consider the costs and benefits before entering into an invoice discounting arrangement.

Read More: How Oil Prices Affect Stock Market

Let’s Understand What Is Invoice Discounting With An Example:

Here’s a real life example to make you understand what is invoice discounting:

Let’s say that you run a small business that sells handmade products to a large retailer. The retailer places an order for Rs. 10,000 worth of your products and agrees to pay you in 60 days after receiving the goods. However, you need the cash flow to fund your operations and can’t wait for 60 days to get paid.

So, you decide to use invoice discounting to get some of the cash you need upfront. You approach an invoice discounting company and provide them with a copy of the invoice you’ve issued to the retailer. The invoice discounting company reviews your creditworthiness, as well as the creditworthiness of the retailer, and agrees to advance you 80% of the invoice value, or Rs. 8,000, upfront.

The invoice discounting company then takes over the responsibility of collecting the payment from the retailer when it becomes due in 60 days. Once the retailer pays the invoice, the invoice discounting company deducts their fee from the remaining 20% of the invoice value, or Rs. 2,000, and returns the balance to you.

In this way, invoice discounting has helped you to access cash upfront to fund your business operations, without having to wait for the retailer to pay the invoice.

Read More: What Is IPO? Types Of IPO & more

Benefits Of Invoice Discounting For Businesses:

Now that you understand what is invoice discounting, let’s have a look at its benefits.

There are several major benefits of invoice discounting for businesses:

1. Improved cash flow: Invoice discounting allows businesses to access cash quickly, which can help improve their cash flow and enable them to invest in their operations, pay bills, and manage day-to-day expenses.
2. Flexible financing: Invoice discounting is often more flexible than other forms of financing because it’s based on the value of a business’s outstanding invoices. This means that businesses can borrow more or less money depending on their needs.
3. Access to working capital: By using invoice discounting, businesses can turn their unpaid invoices into working capital. This can help them fund new projects, expand their business, or take advantage of new opportunities.
4. Reduced credit risk: When a business sells its invoices to a third-party financial company, they take on the risk of non-payment by the customer. This reduces the credit risk for the business, as they no longer have to worry about whether their customers will pay their invoices on time.
5. Confidentiality: Invoice discounting is often confidential, which means that businesses can maintain their relationships with their customers without them knowing that they are using invoice discounting to manage their cash flow.

Check out iTribe app: Stock Market News & Courses

Benefits Of Invoice Discounting For Investors:

There are several potential benefits of investing in invoice discounting for investors:

1. Attractive returns: Invoice discounting can offer investors attractive returns compared to other low-risk investments, such as government bonds or savings accounts.
2. Diversification: Investing in invoice discounting can provide investors with a way to diversify their portfolio and reduce their overall investment risk.
3. Predictable cash flows: Investing in invoice discounting can provide investors with a predictable stream of cash flows, as payments from the businesses that issued the invoices are typically due on specific dates.
4. Lower volatility: Compared to other investments, such as stocks, invoice discounting is generally less volatile and less susceptible to market fluctuations.
5. Reduced credit risk: The risk of non-payment by the customer is borne by the invoice discounting company rather than the investor, which reduces the credit risk for investors.
6. Shorter investment horizon: Invoice discounting investments typically have shorter investment horizons, as the average duration of an invoice is around 30-60 days. This can provide investors with more frequent opportunities to reinvest their capital and compound their returns.

Invoice Discounting Platforms in India:

There are several invoice discounting platforms in India that offer financing options to businesses. Here are some of the prominent ones:

1. KredX: KredX is a digital invoice discounting platform that connects businesses with investors to unlock working capital. It allows businesses to upload their invoices and receive funds in as little as 24 hours.
2. Invoicemart: Invoicemart is a digital invoice discounting platform that offers financing options to small and medium-sized enterprises (SMEs). It is a joint venture between Axis Bank and mjunction services.
3. M1xchange: M1xchange is a digital platform that connects SMEs with financiers to help them unlock working capital from their unpaid invoices. It is a joint venture between Mynd Solutions and the Small Industries Development Bank of India (SIDBI).
4. Lendbox: Lendbox is a peer-to-peer lending platform that offers invoice discounting as one of its financing options. It connects businesses with individual investors who are willing to finance their unpaid invoices.
5. Receivables Exchange of India (RXIL): RXIL is a joint venture between the National Stock Exchange of India and Small Industries Development Bank of India (SIDBI). It provides a digital platform for SMEs to sell their unpaid invoices to financiers.