How can it help me?
Invoice discounting can improve your cash flow by giving you fast access to working capital. If the discounting is ‘without recourse’ (see below), it can also reduce significantly your risk of non-payment.
What is it?
Invoice discounting involves selling your unpaid invoices (or ‘accounts receivable’) to a bank or other financial institution for immediate cash advances. It is suitable for short-term export sales with payment periods of less than 180 days.
It is also referred to as a form of trade invoice discounting, accounts receivable financing or trade debtor financing.
How does it work?
Invoice discounting facilities are available in many forms but they usually involve an ongoing stream of invoices rather than a single invoice.
The main steps in a typical invoice discounting arrangement are:
- A bank or finance company (the discounter) checks your credit standing and business track record, including the profiles of your overseas buyers. If your business meets the discounter’s credit criteria, you agree with them the terms of the invoice discounting facility. This includes limits on your facility and sometimes individual limits on your buyers and/or the countries you export to.
- You establish an account into which your discounter will advance funds against your invoices. You will also deposit payments from your buyers into the account.
- You send invoices to your overseas buyers and forward copies to the discounter. Straight away, the discounter pays you a percentage of the invoice values—usually around 80 to 90 per cent. You are called the assignor of the invoices since you assign the debts to the discounter.
- The amounts you receive as advances may vary each month depending on your accounts receivable ledger, though the advances remain at the agreed percentage of your accounts receivable ledger. As you receive payments from your buyers, you use the funds to repay the cash advances from the discounter, plus interest.
Generally, invoice discounting is ‘with recourse’—you must repay the advance to the discounter regardless of whether the buyer pays you. However, a discounter may acquire some of your buyers’ debts on a ‘without recourse’ basis. This means the risk of non-payment by the buyers is transferred from you to the discounter, as long as you fulfil all your obligations under the export contract. If the buyer doesn’t pay you, you don’t have to repay the advances. However, the discounter will charge a higher premium to discount on a without recourse basis.
Invoice discounting means you keep control of your accounts receivable ledger and payment collection. You may have to give the discounter regular reports on the status of your accounts receivable ledger. The discounter will often check your accounts receivable ledger and credit control systems to ensure they comply with the discounter’s standards.
Invoice discounting is different to factoring, where a factor manages your accounts receivable ledger and takes responsibility for collecting payment from your buyers. The fee structure for invoice discounting and factoring facilities may also differ.
The diagram below shows the main steps in a typical invoice discounting arrangement.
Notes to diagram
- You enter into an export contract with your overseas buyer.
- You provide goods or services to the buyer in accordance with your export contract.
- You send an invoice to the buyer.
- You forward a copy of the invoice to the discounter.
- The discounter pays you the invoice value less the agreed discount.
- The buyer pays you for the goods or services.
- You pay the discounter the amount advanced in step 5, plus interest.
What are the pros and cons?
| Pros |
Cons |
| Can free up your working capital and take the strain off your cash flow |
If the arrangement with the discounter is with recourse, you remain responsible for chasing up payments from your buyers and you carry the risk of non-payment |
| Particularly suited to well-established, rapidly growing export businesses that need quick injections of cash |
A discounter won’t necessarily purchase all your outstanding invoices (for example, if they think the payment term is too long or they believe an overseas buyer or import country is an unacceptable credit risk) |
| If the arrangement with the discounter is without recourse, it significantly reduces your risk of non-payment—as long as you fulfil your obligations under the export contract |
If a large portion of your income comes from a single overseas buyer, your discounter may charge a higher fee to reflect the concentration of non-payment risk |
| Can give you the flexibility to offer open account terms to your customers, increasing your competitiveness in international markets |
Invoice discounting is generally a more expensive form of financing than an overdraft or secured loan
|
| If your export sales are in a foreign currency, invoice discounting may reduce your exposure to exchange rate risk by bringing forward your effective payment date |
|
| Invoice discounting is often provided on a confidential basis—your buyers don’t know you’re borrowing funds against the short-term debts they owe you |
|
| A discounter may not require tangible assets (such as real estate) as security for an invoice discounting facility, especially if you’re a profitable business with a strong exporting track record. However, they might require you to have export credit insurance |
|
What costs are involved?
- You pay a fee (usually monthly) for the invoice discounting facility, as well as a discount fee (interest) on the amounts advanced to you.
- The fees for invoice discounting on a without recourse basis are likely to be higher, reflecting the discounter’s increased risk.
Note: This page contains links to other websites. EFIC does not approve, recommend or endorse those websites or their contents, provides no warranty and takes no responsibility for the accuracy or currency of their contents, your use of the websites or any products or services available on or through them.