Mr. Vinod manufactures solar panels. He just delivered a huge order to one Government office. As per the agreed payment terms, he will get the payment after 3 months. Now, he got another big order. But the problem is he doesn’t have enough money to procure raw materials to fulfil this order. His payment is assured from first order but he will lose the second order if its not delivered on time.
This is where invoice financing can help Mr. Vinod.
In this article, I will try to cover all the aspects of invoice discounting. Here you will get to know about how invoice discounting works, its work process, bill discounting, invoice factoring and much more.
What is invoice discounting?
Invoice discounting is the practice implemented for using a company’s due accounts received as collateral for a loan purpose. You can consider this unpaid amount to be distributed by a finance company. This mode of discounting is a very short-term approach of borrowing due to a reason. The reason is the finance company can change the value of debt unresolved. It is when the amount of accounts receivable collateral varies. The debt amount given by the finance company is low than the amount of outstanding receivables. This is usually 80% of all invoices that are less than period of 90 days old.
You can get knowledge of Invoice discounting here in more depth. Invoice discounting fundamentally speed ups cash movement from clients. The purpose behind this is to not wait for clients to pay within their credit terms. You get cash instantly when you issue the invoice. Invoice discounting is a major source of working capital finance as the limit of bank financing, due to the credit crisis. Invoice finance is more attractive to a bank as it relies on the invoice unpaid security from the debtor.
One can also refer this as an approach for businesses to borrow money based on sums. Invoice financing allow businesses recover cash flow, recompense employees and suppliers, plus reinvest in processes. Businesses normally pay a percentage of the invoice sum to the lender as a payment for borrowing the cash.
What is Bill Discounting?
Bill Discounting is a discount/fee which a bank takes from a retailer to release money. This is the money bank asks before the credit period terminates. This bill is later offered to seller’s customer and complete amount is composed. It is valid in situations when a customer purchases goods and makes payment via letter of credit. For discounting on bill, the credit period may vary from 30 days to as high as 120 days. Based on the credit value of the buyer, the bank carries out the discounts of the amount. Bank then pays this amount at the completion of credit period.
In other terms, it is a trading or selling a bill of exchange before the maturity date. The value is lower to the par value of the bill. The discount amount will be based on time left prior the bill develops. Discount amount also depends on the perceived risk involved to the bill.
The bills or invoices that are included under bill discounting are formally the ‘bill of exchange’. A bill of exchange is a tool which is used only by approving the name. We can consider our currency as a bill of exchange for example. Then currency offers value printed over it is funded to the bearer. In the instance of discounting on bill, these kinds of bills can be either owed to the bearer or due to order. So, after discounting a bill, a bank can get the bill rediscounted from different banks for cash flow constraint.
Benefits of Bill / Invoice Discounting:
The business acquires the cash instantly providing business cycle an improved impetus. Bill discounting permits a financier to run business without funds. This operates in same way as bank overdraft. In this the debtor pays the interest amount only on the sum of money used. There is a rough competition prevailing in the market to range such credit. Henceforth there are many different products to satisfy the requirements of the client.
Difference Between Invoice Discounting And Invoice Factoring
Invoice Factoring and Invoice Discounting both are financial facilities that can release the capitals held in your unpaid invoices. This makes provider who decides to advance money in contradiction of unpaid debtor balances. Factoring is applied by smaller businesses, for example, a start-up business or a small firm. Invoice discounting is taken into account by larger and more reputable firms.
The main difference between these two depends in who controls the sales ledger and accountability for getting payment. The differences are more clearly explained below:
With Invoice Factoring, the provider assumes the responsibility of managing the sales ledger. Other responsibilities are credit control as well as chasing customers for their invoices settlement.
While using Invoice Discounting, your business holds control of its personal sales ledger and follows payment in the normal way.
Another difference between these two is in the range of confidentiality.
Through Factoring, the customer resolves their invoice straight with the Factoring Company. Due to this customers are more probable to be conscious of your Factoring plan. Through Invoice Discounting, customers still recompense you directly. Here there is no necessity for them to recognize that a third party is engaged in this.
Which is appropriate for you?
Whether you go for Invoice Factoring or an Invoice Discounting, it will depend on the business size. It will also depend on your sales ledger management capitals.
If you run a small scale business and your human resources are limited go for Invoice Factoring. The credit control and collection service that originates with Invoice Factoring is probable to outfit you better.
If you run a large scale business, and you own the large human resources then Invoice Discounting suits you better. If you manage information resources to professionally manage your sales record and debt collection, then use this. Invoice Discounting is also used if you want your own business to contract with debt.
Let’s get more clear idea about these two terms by studying their advantages:
Advantages of Invoice Factoring:
• The funds free recover your cash flow position and the extra working capital formed allows your business to rise.
• Invoice Factoring increases your bargaining power, allowing you to capitalise on discounts and early vendor opportunities.
• The cash developed develops alongside your business. This means that as your business expands, you could have admittance to more capital.
Advantages of Invoice Discounting:
• The service is managed on a confidential basis. You remain in interaction with your customers with them ignorant of the capital agreement.
• Large number of human resources gets managed by Invoice Discounting.
Invoice Discounting Companies in India
There are many Invoice Discounting companies that exist in India of which few renowned companies are listed below:
The goal of the Invoice Discounting company is to offer factoring as well as forfeiting services. It encompasses funding and value added services, proficiently and capably, to business entities in India. This discounting services presented by the company will be both global (i.e. Export and Import) and national. These companies offer management solutions and receivables finance at a price that is a value proposal for its customers.
Bills drawn by small-scale companies in India for the purchases made by them and correctly accepted by the purchaser will be financed. This finance will be done against security of bank.
Seller units in India may also provide bank guarantee of the company for getting financial support. Indian companies supporting Invoice Discounting follows an approach in which bills drawn by them, will be financed. For this it must be duly approved by the buyer.
How Invoice Discounting works
Invoice financing works in a manner that discounting is provided by a range of lenders. This is provided by those who will offer you a percentage of the money possessed on your invoices once they are upraised. This implies that money will go into your account instantly. It is irrespective of how long it takes for a customer to recompense after doing invoicing.
Usually, lenders will not supply money equal to the complete value of each invoice i.e. 75% to 90%, which is usual. After the customer has funded the invoice, the remaining sum will be compensated, less the charges of invoice finance lenders.
Invoice discounter lends you money and you must estimate interest rates varying 1.5% to 3.0% beyond base rates. Along with base rates, a management fee in range 0.2% and 0.5% of turnover is added. This clearly decreases your profits however it can be price worth compensating for expectable cash flow based on your invoicing.
(Image source – CeditInfi)
Example of Invoice Discounting
If you finance an invoice for Rs. 10,000 with an invoice factoring company they will usually advance you 80% of the invoice amount. It can be Rs. 8,000 when the invoice is allocated to them. You will then get the balance of the Rs. 2,000 (because it is done as minus the fee charge by the finance company) back when the customer recompenses the invoice. In this complete invoice discounting process, Rs. 2,000 can be seen as the discount.
Consider that Mr. Ram’s business has begun a discounting service with The Invoice Company to assist with cash flow. In this Ram issues an invoice to his customer of price Rs. 10,000 for work he’s previously completed. Ram’s contract with The Invoice Company mentions that the advance percentage of 75. This means Ram is advanced Rs. 7,500 by The Invoice Company immediately the invoice is upraised.
Usually, Ram will upload the invoice to his online account with the moneylender. After that he would receive the advance. Ram’s customer settles the invoice after few weeks, recompensing Rs. 10,000 into a trust account managed by the lender. Through confidential services, from the customer’s view point it will look as they’re funding directly. The Invoice Company then funds Ram the rest amount-Rs.2500 minus their dues. The fees would usually be about Rs. 250-300, so Ram would get between Rs. 2,250 and Rs. 2,200 in this example.
Debt Factoring relates to the sale of a business’ bills to a third party. In debt factoring, the third party is accused with processing the invoices. Also, the business giving the invoices is capable to get loans depending on the predictable disbursements on the invoices. In this, a business will factor its receivable properties to satisfy its present and instant cash requirements.
A debt factoring procedure includes a business retailing its invoices at a discount to a factor. It is a focused on third-party finance business. This factor initially assesses the business, to comprehend how it functions. It also highlights how to evaluate the receivables to regulate if they are collectible. These are important factors when it comes to drawing up the settlement and computing the discount for debt factoring. The debt factor then manages the invoices, accumulating the receivables accounts from customers.
Advantages of debt factoring:
• Debt factoring permits businesses to accept cash directly for invoices on their records without waiting for customers to pay.
• They can simply use this cash to assist them grow.
• Debt factoring offers a cost-effective collection strategy as the business does not have to apply its resources to follow and gather receivables.
Invoice Discounting is actually a method followed to make complete use of company’s due accounts. If done well, this can help business owners to manage their cash flow efficiently.
It is advised to use a good accounting software to record income and expenses so that invoice financing companies can process the application quickly.See How ProfitBooks Can Help