What is Invoice Discounting?

Invoice discounting is a financial transaction in which a company borrows money using its accounts receivable (invoices) as collateral. The company typically sells the invoices to a lender at a discount, and then repays the loan plus interest when the invoices are paid by the company's customers.

The use of a company’s accounts receivable as security to obtain funding from third parties or financial institutions is known as invoice discounting. This type of borrowing is typically for a limited time. Financial institutions make loans for less than the invoice amount due.

In invoice discounting, unlike invoice factoring, the business is responsible for collecting invoices. As a result, receivables are exposed to the risk of bad debt. Some financial institutions provide bad debt protection but at an additional cost. During a period of rapid growth, this method is used to increase temporary cash flow in the business in order to buy more raw materials or to pay payroll.

In general, there are three kinds of invoice discounting: turnover-based, selective invoices, and confidential discounting. Lenders charge higher fees for funding specific invoices, which can raise the business’s operating costs.

Did you know?

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