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Invoice Discounting - The Pros and Cons
Those businesses that sell their goods or services on credit are well aware of the costs involved in waiting between the day they send out their invoice and the day the customer pays up. The business has to provide finance during the gap between invoice and payment and this is known as “working capital”. As the business gets bigger, so does the working capital requirement – and if the money is borrowed, up go the costs!
Back in the day, many businesses funded their working capital via bank overdrafts. We all know that “the day” is long gone – and therefore other forms of financing are becoming more popular.
One of the better known alternatives is “invoice discounting”. This works by an Invoice Discounting Company (“IDC”) offering to fund a certain percentage of your invoiced sales each month. Therefore instead of having to wait 30 days for your customer to pay, the IDC advances you the money straight away. Percentages of invoices advanced vary from company to company (remember to shop around!) but a good rule of thumb would be around 70%. When the customer pays you, you repay the IDC.
Naturally there are interest charges and management fees involved, but once again these vary between IDCs. Most businesses find that the costs are comparable to bank overdraft rates.
Is there a downside? Like most business transactions, there are disadvantages, so here are a few pros and cons that are worth considering:-
Advantages
- Once the deal with the IDC has been set up, obtaining the advances is relatively simple and straight forward;
- Interest and charges are on a competitive par with bank overdrafts
- Many IDCs have strong local presence allowing you direct contact with a manager in your area
Disadvantages
- Many people think that the IDCs carry out a debt collection/credit control function. They don’t. Responsibility for getting in the debts from customers remains with you.
- The IDC won’t necessarily take on all of your customer invoices. They may choose not to advance funds on what they consider to be “high risk” customers.
- The IDC will take security over the debtor book. This means that as far as the sales ledger is concerned, in the event of a formal insolvency, the IDC is first in the queue when it comes to getting paid.
We are often asked the difference between a debt factoring and an invoice discounting arrangement. In very broad terms, if you factor your debts, you are essentially “selling” them to the factoring company. So all of the responsibilities of the debt collection and credit control can end up passing to the factoring company – but so does the legal title (ie the ownership) of your debts. For this reason, factoring your debts tends to be more expensive than invoice discounting.
All in all the decision as to which method of funding to go for can be a difficult one and depends very much on the type of business you are involved with and how you run the accounting side of your operations. If you feel you need any help or assistance in making this decision, then please contact Jeanette, Carol or Jackie on 0800 9540520.
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