A Reference Guide to Trade Finance TechniquesInvoice discounting
Invoice discounting is similar to factoring, in
the sense that the finance is provided against
the sale of a company’s invoices. Unlike
factoring, there is no credit management
service, so the company retains responsibility
for collecting payment from customers and
maintaining the company’s sales ledger.
Like factoring, invoice discounting
allows the company to receive cash very
shortly after raising an invoice. However,
this arrangement is not usually disclosed
to customers, as the company retains
responsibility for collecting the payments and
chasing bad debts, and the invoice discounter
has no direct relationship with the company’s
customers at all. That said, the invoice
discounter will assess the quality of the
company’s customer base before agreeing to
offer finance.
Invoice discounting is commonly available
to slightly larger companies than can access
factoring. This is partially because the
invoice discounter will want to be confident
in the company’s track record of collecting
on the invoices.
Invoice discounting is available from
subsidiaries of banks as well as from
specialist providers.
How it works
Invoice discounting is a long-term financial
arrangement between the company seeking
to raise finance and the invoice discounter.
As with factoring, it is used to accelerate
cash collection, reducing the reliance on loan
finance to bridge the gap between issuing the
invoice and receipt of cash.
When seeking to discount invoices, the
company will need to identify whether it can
proceed, especially if alternative funding
arrangements, such as overdrafts, are in
place. This is because pledging invoices to
the invoice discounter will affect the way the
company’s liquidity is viewed by the other
finance providers, or may breach undertakings
given to other providers of finance.
In order to be suitable, the invoice
discounter will want to explore the company’s
business, including its cash flow, before
entering into an agreement. In general terms,
companies that are suitable for financing by
a factoring company (see above) are also
suitable for invoice discounting. However, the
invoice discounter will also assess the quality
and effectiveness of the company’s accounts
receivable processes before entering into an
agreement, as these will remain under the
control of the company.
The invoice discounter will also set limits
to the agreement. At the very least, the
discounter will set a limit on the maximum
advance relative to the value of the invoices.
This will vary, but will typically be in the range
80–90%. In addition, the discounter may
impose a limit on the absolute level of credit
it is prepared to advance to the company.
As with factoring, the invoice discounter will
seek security from the underlying assets. If
these may be difficult to recover and sell to
other parties in the event of non-payment, an
invoice discounter may refuse to agree terms,
or may only do so on a lower proportion of
the invoice value.
It is important to negotiate appropriate
terms with the invoice discounter before
entering into the agreement. In particular, the
process by which the discounter approves
invoices needs to be appropriate, ensuring
the company benefits from being able to
raise cash on the most number of invoices.
Any credit limits imposed by the invoice
discounting company should be assessed for
the same reason. The discounter’s method of
advancing payment must also be understood.
Finally, the company must understand the
nature of the agreement period, especially
the notice which both parties must give to end
the agreement. (Bear in mind the discounter
may also decide to end the agreement.)
As with factoring, the company should
also perform its own credit check of the
invoice discounter. However, because the
company retains control of the sales ledger
in invoice discounting, the impact of the
invoice discounter’s failure would be less
devastating than a factor’s failure. This is
because the company’s customers still make
payments through the company (rather than
to the invoice discounter). In the event of the
failure of the invoice discounter, the company