What Is Invoice Discounting, And How Does it Work? Its Benefits For SMEs

Benefits For SMEs

Invoice discounting is an alternative financing solution. Using it, business owners can sell their outstanding invoices to a third party company. MSMEs often have one major problem in common. They don’t have enough working capital to run the business efficiently. And invoice discounting is your perfect solution for such a scenario. It provides you the working capital right when you need it. In this article, you can learn what invoice discounting, how it works, and its benefits are!

Do you know that 82% of businesses fail because of poor cash management? Well, however unpleasant that may sound, but that is true. As a small business, you may already have a limited number of clients. And even if one of your clients delays the payment, it may leave you with lower working capital. When you don’t have enough working capital, it can lead to canceled investments, reduced payroll, or downsizing, etc.

But, do not worry, as invoice discounting can solve your problems related to working capital.

What is invoice discounting?

You can think of invoice discounting as the simplest form of invoice financing. Similar to other invoice finance options, invoice discounting allows you to sell outstanding invoices to a lender. And lenders give you money in advance, which is a certain percentage of the invoice’s value. When your customer pays the invoice, your lender offers you the remaining balance minus their fee.

You can also say that invoice discounting is nothing but a short-term loan. Here, you use your invoices as security. In simple words, the lender already knows that your customers owe you a certain amount. So the lender gives most of that amount before your customers pay you.

This type of financing is quite similar to invoice factoring. But the only difference is invoice discounting is a private affair. You need not disclose your customers that you have taken cash flow finance. And it also means that you will be chasing invoices like you normally do. All in all, invoice discounting gives you the capital to keep your business operations running smoothly. And you can also use that amount for investment or business expansion.

How does invoice discounting work?

Invoice discounting is like an overdraft facility or a short term loan. Here, you secure the loan with your account receivables. The process of invoice discounting is pretty simple. And you can read it below.

  • You sell your products or services to your clients as usual.
  • You raise invoices for those products or services. And you send it to your customers.
  • Now comes into the picture invoice discounting company. They lend you a particular value of the raised invoice less a small percentage. Of course, the lender verifies that the invoices are valid before lending you money.
  • Your customers are likely to pay as per the usual payment terms. Since you’re a credit controller, it’s your duty to chase invoices.
  • After your customers pay you the amount, it’s your time to repay the loan amount to the lender. Along with that, you need to pay an agreed amount that covers costs, interest, and risks.
  • Sometimes, your customers might make a payment towards a trust account holding your business’s name. But, in reality, that account would get controlled by your lender. It lowers the risk of non-payment from your side. At the same time, it also offers you confidentiality.

Benefits of invoice discounting for MSMEs

Now that you know how invoice discounting works, below are five key benefits of it.

1 – Quick cash

One of the biggest benefits of invoice discounting is that you can quickly raise an invoice. It can help you explore a new business opportunity. As soon as you issue an invoice, you can get access to liquid cash in no time. Some companies can provide you the amount in as little as 14 to 72 hours. You can use that money to expand your business, boost sales, and investment purposes.

2 – Improved cash flow

When your clients don’t pay on time, it may hold you back from ensuring smooth operations. Thanks to the invoice discount, it can give you up to 90% of your invoice amount in no time. Also, the invoice discounting companies don’t require you to pledge your valuable assets. You only need your invoices as security. So, it becomes easy to secure financing and improves cash flow in your company.

3 – Releases locked finances

When you raise an invoice to your customer, he is likely to pay after a set period. It typically takes 4-10 weeks for the payment to get processed. In some businesses, it takes even more time to receive payment from your client. But, invoice discounting helps you release that locked capital. This is super helpful in cases where you complete the contractual obligation early. But payment might be pending from the client’s end as per the original schedule.

4 – Maintains confidentiality

Many business owners feel skeptical when going for any financing options. You might not want your client to know that you are using invoice financing services. Thanks to invoice discounting, it offers you complete privacy. The agreement between you and the lender is confidential. And your client need not know anything about it.

5 – Control over the sales ledger

When you are using alternative finance like invoice discounting, your company’s control of sales ledger remains. Right from collecting payments and chasing invoices, it’s you who need to do everything. As a result, your relationship with clients won’t get affected by any means. This way, you can ensure maximum customer satisfaction too.

To put it all together

Those were the benefits of invoice discounting for MSMEs. It improves the cash flow in your business. You get quick access to working capital too. All you need to do is raise your unpaid invoices. And sell them to an invoice discounting company. Keep in mind that the discount you get depends on the due date of your invoices and the risk involved.