Invoice discounting

With 1 in 4 small businesses in the UK owed between £5,000 and £20,000 in unpaid invoices, it’s no surprise many UK-based businesses regularly leverage invoice discounting.

Here’s what invoice discounting is, the pros and cons, and some guidance on how to decide if this is a tool you’d like to use for your business.

What is invoice discounting?

Waiting for customers to pay invoices can put a strain on small-to-medium sized businesses’ cash flow. That’s where invoice discounting comes in.

Invoice discounting definition: Invoice discounting enables businesses to gain instant access to cash tied up in unpaid invoices and tap into the value of their sales ledger. It’s simple – when you invoice a customer or client, you receive a percentage of the total from the lender, providing your business with a cash flow boost.

Please note that invoice finance is only as good as the strength of your debtors and it can be admin heavy.

How does invoice discounting work?

Another way to look at invoice discounting is by seeing it as a series of short term business loans using invoices as security. In other words, the lender knows that you’re owed the money, so will lend you most of it before your customer has actually paid you. 

It works like this:

• Step 1: Raise the invoice and deliver the services

• Step 2: Sell the invoice to the lender

• Step 3: Your customer pays the invoice (it’s still your job to make sure they do pay)

• Step 4: Repay the lender

• Step 5: Depending on your agreement with the lender and your preferences, you may be able to repeat the process

Invoice discounting example

Joe’s Business has just started a discounting facility with The Invoice Company to help with cash flow, and Joe issues an invoice to his customer worth £10,000 for work he’s already completed. Joe’s agreement with The Invoice Company states that the advance percentage (also known as 'initial percentage' or 'prepayment percentage') is 75% – that means Joe will be advanced £7,500 by The Invoice Company as soon as the invoice is raised.

Joe’s signed with a digital-first lender, so he uploads the invoice to his online account with the lender and then receives the advance.

Joe’s customer settles the invoice a few weeks later, paying £10,000. The Invoice Company then pays Joe the remaining £2,500, minus their fees. The fees would typically be around £250-300, so Joe would receive between £2,250 and £2,200 for this scenario.

This is a basic example, but the same principle can be applied to invoice discounting across the whole sales ledger. Of course, there are sometimes more specific terms and conditions involved, like maximum accounts receivable, minimum period, maximum overdue accounts, and so on.

What can I use invoice discounting for?

Let’s take a look at the different ways a small business may wish to use invoice discounting:

Support cash flow

Cash tied up in unpaid invoices can become a burden on healthy cash flow. After all, suppliers won’t necessarily wait until your clients pay to collect. This is particularly true for B2B business, where 30, 60, and even 90 day terms are fairly standard. Invoice discounting can essentially remove this issue by providing the funds shortly after the invoice is raised.

Enable growth

Growth often needs money to fuel it. Whether that’s in the form of hiring new talent to take on new clients, promoting with more vigour across social media and paid ads, or purchasing new stock in the run up to Christmas to sell on at a profit. Invoice discounting can be a way to provide some of that growth-enabling cash up front.

Cover emergencies

When a company emergency hits, for example, an essential piece of equipment breaks, getting the cash together can be a bit tricky. Invoice discounting provides a suitable middle ground between taking out a long-term loan and paying the funds upfront.

Marketing

Ads, agencies, content, and branding all cost money. The funds from invoice discounting could be used to lay the foundations for a solid marketing campaign, commit to a rebranding, onboard a new marketing intern, or increase ads distribution.

Business development

Whether you need to pay your new account executive or need to fund a trip abroad to close a deal, invoice discounting could be a suitable way to fund business development activities.

Pay off a tax bill

Sometimes, one or two months is all that’s needed to cover a corporation tax or VAT bill. If you’ve found yourself in a similar circumstance, invoice discounting could be the answer.

Invoice discounting advantages

There are many benefits to invoice discounting, including:

• Speed: Invoice discounting, by its nature, is a fast-moving funding solution. Since invoices have quite short deadlines for payment, eligible borrowers can find the funding to be much quicker than, say, a commercial mortgage. Some borrowers can see funds hit their account within 24-48 hours

• Flexibility: With invoice discounting, you choose the invoices you want to use as security and for how long

• Control: Unlike some instances of invoice factoring, you retain control over your relationships with your clients – you chase, close, and collect the funds

• Privacy: Similar to the above point, your clients don’t need to be informed as the agreement is between you and the lender, not your client and the lender. You are still responsible for the funds – this means no loss of privacy surrounding your finances

• Growth: As you raise and collect more invoices, if the lender is agreeable and if you remain eligible, you could scale the number of invoices you use invoice discounting for. You can also downsize on tighter months, or, you could pause if you simply don’t need to use the funding solution for a given month

• Suppliers: Paying your suppliers on time can have a positive impact on your relationships with them – poor supplier relationships can result in delays in services, which can have an impact on your end customer. Invoice discounting can enable you to pay your suppliers in a timely manner instead of waiting on your customers to settle payments

Invoice discounting disadvantages

On the other hand, there are also a few disadvantages that are important to consider before entering into an invoice discounting agreement:

• Client payments: While this can be an advantage in that you retain control, it can also be a disadvantage, in that you are still responsible for chasing and collecting payment and if a client doesn’t pay, it’s your responsibility to ensure the debt is still repaid. This can result in added pressure if a specific client isn’t paying and could result in you chasing invoices extra-hard, since you’re no longer the only party involved

• Credit score: Missed payments and defaults can have a negative impact on your business’s credit score and creditworthiness. Without an emergency fund set up, you run the risk of clients not paying, either at all or in time, and you take a hit to your personal or company credit score. The lower your credit score, the more you’re likely to have to pay when borrowing in the future

• Reduced income: You will not receive 100% of the invoice. Instead, the lender will keep some of the funds as a fee. This number can stack up as you scale

• The debt trap: Similar to a revolving credit card facility, invoice discounting can get you caught in the debt trap. This happens when you begin discounting all invoices on a monthly basis. The problem here is invoice discounting often comes with an inherent fee, so over-reliance results in you losing money even if you repay the loan on time every single time. Before entering into an agreement with a lender, come up with a plan for ensuring you don’t end up in this trap

• More work: Managing an invoice discounting facility requires some work. Rather than just raising the invoices and moving on and then occasionally chasing if a deadline passes, invoice discounting requires time taken to consider which of your customers pays on time every single month, which invoices you’d like to use for discounting, and to ensure payment is made before the lender’s deadline.

What is confidential invoice discounting?

Invoice discounting is normally confidential (it's sometimes called 'confidential invoice discounting'). You’ll continue to deal with customers yourself as normal – your customers won’t know you’re using a finance provider. The downside to this is that you’ll still have to chase invoices yourself, unlike invoice factoring.

Invoice discounting vs invoice factoring

Invoice discounting is similar to factoring, however there is one fundamental difference. With factoring, your customers might know that you're in receipt of finance because the lender will typically manage your sales ledger and credit control processes. As such, they’ll chase any late payments on your behalf. On the other hand, invoice discounting allows you to retain autonomy over all communications and customer service. When it comes to fees with regard to invoice discounting vs invoice factoring, discounting is often the cheaper option. 

What impacts how much you’ll be charged for invoice discounting?

Here are some of the things that can impact how you’ll be charged for invoice discounting.

Value of invoices

How large the invoices are will have an impact. Think of it like this – if your client doesn’t repay an invoice worth £20, chances are you can find that money elsewhere. But if your client reneges on an invoice worth £1M, you’ve got a big problem and that problem will likely be passed onto the lender, as they’ll need to chase you on this very large payment. This increased risk can result in an increased fee – but it’s not that simple. The administrative tasks the lender must engage in to organise invoice discounting for each invoice are similar, so you may receive a reduced fee, rather than an increased one, in particular if your lender perceives you to be very trustworthy. The only way to truly ascertain how the value of your invoices will impact your fee is to talk to your lender, or our support team – they should be able to help you get a clearer picture surrounding fee structures.

Company size

Smaller companies can suffer from higher rates when it comes to invoice discounting. It is unfortunate, but inescapable, that larger businesses may have more to leverage when it comes to negotiating with lenders. This can make invoice discounting both an easier and cheaper solution for them than their smaller peers. If you’re looking for invoice discounting and you’re a small business, feel free to get in touch with our team. We’ll see if there’s any way we can help.

Number of invoices

As mentioned, the bargaining power of having many invoices discounted is not to be underestimated. In some cases, lenders even offer a scalable pricing system that reduces the fee per invoice as the number of invoices increases. This could lead some businesses into that debt trap we spoke about before – after all, if more invoices equal a reduced fee, it can become easy to slip into a mentality of “I’m saving money.” Be cautious, tread carefully, and consider each invoice as if it were its own mini-loan. Always ask yourself, “how can I repay this loan if my client defaults? How often does this client repay on time? Am I prepared to take the risk?”

Creditworthiness

Creditworthiness is a measure used by lenders to assess how likely you are to repay a loan. Lenders evaluate the creditworthiness of loan applicants by taking into account their credit score, bill payment history, outstanding company debt, assets vs liabilities, and profitability. High creditworthiness often equals a lower rate, whereas low creditworthiness usually means a higher rate. If you apply as a limited company, the lender will likely look at your company’s creditworthiness. If you apply using a personal guarantee or you apply for a sole trader loan, the lender may look at your personal creditworthiness. That said, it’s not unusual for lenders to look at both.

Track record

Your track record with debt will also have an impact on how much a lender is likely to charge for invoice discounting. A better history with debt could result in a reduced rate, whereas a negative history with debt would have the opposite effect.

How to apply for invoice discounting

Start by finding the most suitable lender for your business. One way to do this is by turning to a broker. Brokers develop professional relationships with a range of lenders over time. This enables them to gain access to a wide variety of options for eligible borrowers, so they can often help borrowers pick and choose the most suitable, or cheapest, or most flexible options.

If you’d prefer to do the search solo, start by using a search engine or turning to a local information source to gather together a wide range of quotes and lenders, then narrow down your results by comparing fees, services, reviews, and compatibility.

Next, take a look at which invoices you would like to submit for invoice discounting. You’ll likely want to search for a balance between reliable customers and long invoice payment due dates. For example, an invoice from a customer who has paid every single month for the last two years, but whose invoices include 30-day payment terms, could make a suitable candidate.

Now it’s time to chat to the lender. If you use a broker, they can put you in touch with your chosen lender. If you’ve used a search engine, fill in the lenders online application forms or give them a call to apply. You may need to provide cash flow projections, company information, or a personal guarantee.

Then it’s time to wait. You should hear back with an approval or rejection quite quickly. If you’re approved, once the funds hit your account, you’ll want to keep a note somewhere of when the money is owed so you can be sure to follow up with your clients on time.

Is invoice discounting right for you?

Only you can really decide if invoice discounting is the most suitable solution for you. However, here are some examples of companies where invoice discounting may be a good answer, and some where it wouldn’t be.

Example A: Company A is a mid-sized B2B enterprise. They raise a lot of invoices and have standard payment terms of 30 days. They’d like a short term cash injection to help pay for a new industrial-level printer. 

They only want to use invoice discounting for a few invoices and due to their size, they’ve been able to find a lender who is offering quite low fees. Their accounting team is very on top of invoice chasing and the invoices they want to use for discounting have been raised with very reliable clients. They’ve got great relationships with their customers but they want to keep this confidential.

In this instance, invoice discounting may be a suitable solution.

Example B: Company B is a small B2B company and they’re wondering if invoice finance is a suitable option for their start up. They’ve been in business for around 1 year and they’re finally starting to get some clients signed up. Company B is made up of three founders and they each contribute to projects with their own time, so they are able to deliver on all client projects without external support and fortunately, at this time, they don’t need to pay suppliers before clients settle invoices.

Company B believes (since they now have some solid case studies) it’s now time to put together and execute a marketing plan and onboard their first employee—a business development executive. But they would need additional funding to facilitate this. They would like to take out a loan to kickstart these activities and would like to spread the cost over an extended period, to ensure they’re able to repay the loan in full as they grow in size.

In this instance, invoice discounting might not be a suitable option. In fact, a short term loan in and of itself might not be the right answer for them. Company B may want to consider a government backed start up loan, which would enable them to take out up to £25,000. This type of loan would come with 12 months of free support and guidance, which could be essential for a business this young. These loans also come with a set interest rate of 6%, have no application or early repayment fees, and can be taken out for 1 to 5 years.

Why choose Funding Options to help you apply for invoice discounting?

We’re one of the leading brokers for UK businesses and sole traders. With a network of over 120 lenders offering between £1,000 and £20M, our team of experts is well positioned to help guide borrowing companies through the often tricky process of finding and applying for business finance.

We can help eligible borrowers find invoice discounting (hopefully at a rate they’re happy with) but we can also help borrowers choose a different form of funding if they’re not 100% happy with the options available. Rather than spending hours scrolling through search engines looking for lenders, comparing fee rates, and checking reviews, we may be able to help you streamline the process and find the lender best suited to your unique needs.

Here are some thoughts from a few of our happy customers:

Indie Brands said, "Funding Options basically took all the hassle out of it. We've now been able to expand the company to a point where the next step for us will be to bring in investors over the next year."

Recruitment company fdu said, "I've been impressed with Funding Options. They took the time to really understand our requirements and have connected us with funding providers who have taken a commercial and flexible approach. I have recommended them on several occasions and will continue to do so."

And Minerva Crafts, a family-run business in Lancashire, were kind enough to share this: "Excellent first conversation, it made me feel like they might be able to do something for our business which was very positive. The person I spoke to was very helpful and explained the process in great detail."

If you’d like us to match you with a suitable lender, just start your application and we’ll be in touch shortly to let you know if you’re eligible.

Invoice discounting alternatives

If you’re looking for something a little different, there are many alternatives to invoice discounting. Which one to use depends on your requirements.

• Invoice factoring: Unlike invoice discounting, which is essentially a secured business loan where your invoices are used as the collateral, invoice factoring is the actual sale of your invoices in exchange for cash. Both are different types of finance that sit under the invoice finance umbrella, so if you’re looking for an alternative to invoice discounting, invoice factoring is one possible option

• Bridging loans: Bridging loans are a form of short term funding, they’re usually used to pay for property development or acquisitions while the buyer or developer waits for additional funding, for instance, in the form of a mortgage or sale. Bridging loans don’t have to be used for property, but they do need collateral

• Company credit card: Business credit cards are used to pay for business related costs, for instance, inventory or office suppliers, and are then (usually) repaid on a monthly basis. The funds can then be reused the following month

• Revolving credit facility: This is similar to a business credit card (in fact, company credit cards sit under the umbrella of revolving credit facilities) except they don’t necessarily need to come in the form of a card that can be drawn from. Cash and cheque based revolving credit facilities are available to eligible businesses, making this a possible option for any businesses looking to meet payroll obligations or pay suppliers

• Short term business loan: Short term business loans generally come with shorter repayment terms and higher rates than their longer term business loan counterparts. They supply a quick cash injection that can be used to cover emergency expenses

• Asset finance: Asset finance generally refers to one of two things. The first is the ability to lease, borrow, or purchase an asset and spread the cost, for example, this type of funding can be used to buy a truck on finance. The other type of finance is called asset refinance – this allows you to borrow against an asset you already own, giving you access to funding while retaining use of the asset

Overdraft: Business overdrafts are usually facilitated by a financial institution you already use in some capacity, for example, you may have an overdraft with a bank you currently have a current account with. It’s a pre-approved line of credit designed to cover short term expenses and is usually repaid within the month

FAQs

Apply for invoice discounting with Funding Options by Tide

We help match eligible borrowers to our network of over 120 lenders offering a range of different financing options, including invoice discounting. Just click the link below and fill out the form to find out if you’re eligible to borrow anywhere between £1,000 and £20M.

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Please note that the information above is not intended to be financial advice. You should seek independent financial advice before making any decisions about your financial future.

It’s important to remember that all loans and credit agreements come with risks. These risks include non-payment and late-payment of the agreed repayment plan, which could affect your business credit score and impact your ability to find future funding. Always read the terms and conditions of every loan or credit agreement before you proceed. Contact us for support if you ever face difficulties making your repayments.

Funding Options, now part of Tide, helps UK firms access business finance, working directly with businesses and their trusted advisors. Funding Options are a credit broker and do not provide loans directly. All finance and quotes are subject to status and income. Applicants must be aged 18 and over and terms and conditions apply. Guarantees and Indemnities may be required. Funding Options can introduce applicants to a number of providers based on the applicants' circumstances and creditworthiness. Funding Options will receive a commission or finder’s fee for effecting such finance introductions.