What is invoice discounting and how does it work?

April 15th, 2020

Understanding invoice discounting, how it differs from invoice factoring, and whether it’s right for your business.

Invoice discounting is a form of invoice finance. Invoice finance, also known as debtor finance or accounts receivable finance, is a common way for growing businesses to fund increasing working capital requirements, by unlocking the capital tied up in unpaid invoices. 

Using your sales ledger as loan security can be an effective way to access finance on terms more attractive than unsecured business loans, without using real estate security.

What is invoice discounting and how does it work?

Invoice discounting is a type of short-term business finance that uses a company’s unpaid invoices as collateral. The amount of finance a business can access depends on the amount outstanding and typically lenders advance up to 80% of the accounts receivable ledger. 

The loan is repaid when customer invoices are paid and as new invoices are raised the business can access funds again. This makes invoice discounting a type of business finance that keeps businesses borrowing within their capacity.

As the available finance is linked to invoice value, it grows in line with the accounts receivable. This makes invoice discounting a popular product for small and medium sized businesses that require finance to generate the next round of sales.

Woman conducting a business meeting in an office

The benefits of modern invoice discounting

Modern invoice discounting providers like Earlypay integrate with Xero, MYOB and Quickbooks. With this connected integration, invoices can be viewed automatically and in real-time, which saves time for business owners and their teams.

Cloud accounting software platforms also solve a big pain point of traditional debtor finance - reconciling invoice payments to invoices. Earlypay and other modern providers automatically post journal entries to your accounting software, allowing bookkeepers to reconcile invoice payments and loan repayments to bank transactions instantly.

What is the difference between invoice discounting and invoice factoring?

While both types of invoice finance, there are some notable differences between invoice discounting and invoice factoring:

Invoice Factoring

Under an invoice factoring arrangement, a business sells its invoices to the factoring company at a discount to the full value of the invoices. When the invoice is paid by the customer, the remaining value minus fees is forwarded to the business.

With invoice factoring, the responsibility of managing and collecting the invoices is passed to the factoring company. In this scenario, the debtor is aware of the arrangement and makes payments directly to the provider.

A benefit of factoring invoices is that business owners can focus resources on running the business instead of chasing collections. The flip-side of this is that the factoring company will now be contacting your customers, and they might not always deal with them in the same way you would.

Invoice Discounting

With an invoice discounting arrangement, customer invoices are not sold to the lender but are simply used as security for the loan. The business therefore retains responsibility for managing the accounts receivables ledger and collecting invoices so the business maintains control of the customer relationship.

Invoice discounting is generally undisclosed (or confidential) as the customer is not aware that an invoice discounting service is being used. 

Why use invoice discounting?

Bringing forward cash flow from unpaid invoices can be a great way for growing businesses to fund increased working capital needs. This includes things like buying inventory or adding more headcount to meet new orders.

Invoice discounting is a quick and easy way for business owners to access their account receivable ahead of client payment. This not only accelerates the cash flow, it also provides certainty in cash flow, as the timing of invoice payments is often unpredictable and can take longer than expected. 

How much finance can I get?

You can usually access up to 80% of eligible invoices. Eligible invoices are usually:

  • For goods or services that have been completed
  • Made out to customers with a good credit standing
  • Less than 90 days past the invoice issue date

Am I eligible for invoice discounting?

Invoice discounting providers assess the eligibility of your business based on your business’ credit history and financial circumstances, as well as the credit history of your customers. 

Factors providers consider include revenue, existing debt levels, and the time you have been in business. In the case of Earlypay, we would look for:

  • A valid ACN
  • More than 12 months in business
  • Invoices with other strong Australian businesses
  • Invoices issued after goods or services have been delivered
  • At least $1m annual revenue
  • Minimum of three customers
  • Integration with Xero

Is invoice discounting right for my business?

If your business meets the above eligibility criteria, there’s a good chance that an invoice discounting arrangement could benefit your business.

While invoice discounting can be more expensive than finance secured by real estate, it’s cheaper than other unsecured business loans. And many business owners are unable or unwilling to mortgage their house for their business, but don’t want to break the bank on high interest repayments for unsecured loans. 

Therefore, using unpaid invoices as security for invoice discounting can be an attractive alternative. Invoice discounting is also more flexible than business loans that have a fixed term and fixed repayments. This is because borrowers can draw funds when they need them, and only pay for what they borrow.

Every business is different and there’s no one-size-fits-all solution in business finance. So, be sure to do your research. Carefully consider which type of finance best suits the needs of you and your particular business.

If you would like to learn more about invoice discounting with Earlypay to see if it’s right for your business, please contact our team today on 1300 760 205

If you'd like to learn how Earlypay's Invoice Finance & Equipment Finance can help you boost your working capital to fund growth or keep on top of day-to-day operations of your business, contact Earlypay's helpful team today on 1300 760 205, visit our sign-up form or contact [email protected].