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Key Advantages and Disadvantages of Invoice Discounting

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Small businesses need an adequate flow of cash as working capital. Today, there are various financing options available in the market for funding the capital requirements of a business. Loans, lines of credit, overdrafts, and also invoice or bill discounting are the widely used methods of working capital finance

Bill Discounting as a means of Working Capital finance

Invoice discounting or bill discounting involves selling an invoice to a lender or a financing company by a business. In return, the business gets a reduced amount billed to the client on a discount. The collection of the final payment from the buyer now becomes the responsibility of the lender.

Bill discounting provides ready access to cash to businesses and helps to improve their cash flow and working capital cycle. It is a widespread method used for financing used when companies want to capitalize on the waiting period of their invoices. 

Below we present a table to illustrate, and discuss the advantages and disadvantages of discounting invoices:

ADVANTAGES OF BILL DISCOUNTING

DISADVANTAGES OF BILL DISCOUNTING

Fast Cash

Higher cost

Increased cash flow

Reduced profit margins

Asset free Collateral option

Volatile

Reduces collection period

Needs compliance

Speeds up the working capital cycle

Not suitable for start-ups

Confidential

Limit finance options

Advantages of using Bill Discounting 

Fast Funding for Business operations

  • Invoice discounting is a fast method of securing cash for your business when compared to applying for a loan. 

  • In the case of loan applications, the banks or the credit institutions take time for background credit checks of the borrower.

  • Invoice or bill discounting, on the other hand, immediately provides liquid cash to businesses upon the issue of the invoice. 

  • The business can get funds in 24-48 hours.

Cash Flow Increase in business

  • It increases the cash inflow into the business. 

  • This is done by converting accounts receivables (A/Rs) or sales into cash.  

  • Generally, customer invoices have locked cash for an extended period. Invoice discounting converts the company’s account receivables into ready cash which can be used for urgent business needs. 

Asset-free collateral option

  • This method of finance does not require any fixed asset as security.

  • This means no high-value collaterals need to be provided for securing the funds.

Collection period reduction

  • Invoice discounting helps to solve cash flow issues in the business.

  • With this method in place, the businesses need not wait 30 days or more for payments from their business customers. 

  • The business can secure funds even before the collection period is over. It is a significant relief as cash flow is not further strained after repaying the credit amount.

Speeds up Working Capital Cycle 

  • Bill discounting results in a release of cash that has been locked in unpaid invoices from the buyers. 

  • This availability of cash is vital for businesses that depend on a smaller number of clients with large invoice values. 

  • Any payment misbalances that may arise due to the late payment of a single can be leveled out with bill discounting.

  • It keeps the business running by accelerating the working capital cycle.

Makes early payment of suppliers possible

  • The business can now secure funds readily by using its invoices as collateral.

  • More raised invoices on the invoice discounting platform increase the amount available to the business.

  • As the business starts having funds available, it can use them to pay its suppliers and accelerate purchase operations.

Steady business Relations

  • When bill discounting is used as a method of business finance, the borrower company can get the cash it needs readily. 

  • On the other side, the buyers or the customer can also make use of the invoice credit period. 

  • The result is a win-win situation for both the business and its customers. It helps to build healthy business relationships with customers.

Confidentiality 

  • This method of finance maintains confidentiality by the discounting houses. 

  • It means that the agreement between the lender and your business is not disclosed to the buyers or the customers. 

  • In the case of invoice factoring, your clients get alerted as to the fact that you are using the invoices for factoring. However, in this case, the customers do not come to know about the discounting of sales invoices. 

Disadvantages of Invoice Discounting

The higher cost of funds

  • This method of bill discounting has a higher cost than other methods of finance for a business.

  • There are various fees added to it in the form of discount charge, credit management, and credit protection fees, etc., which add up to decrease the total percentage of the amount received by the business.

Reduction in profit margins

  • The fees charged by the lender or the invoice discounting platform add up as a cost to the company.

  • It results in a reduction in the profit margin of the company taking this finance option. 

Limited to companies with a fixed turnover

  • Invoice financing is available to companies that meet a specific turnover limit. Smaller enterprises may find it challenging to find lenders to discount their bills.

  • Even if some lenders get ready to finance the invoices, this is done at high rates of interest which can prove expensive to the company.

May limit finance options

  • Some lenders may require a company’s accounts receivables as part of the loan collateral.

  • In cases where the business invoice becomes an asset of the finance company, such agreements may limit the company from further securing additional finance.

  • The stakeholders of a company may not support reliance on invoice financing in excess.

Invoice Discounting Platform: 

A suitable invoice discounting platform can help your business to keep up with seasonal cash flow demands. Today, many NBFCs and organizations are coming forward to provide safe, secure invoice finance options on an online platform. These options are quick, easy, and with minimum documentation.

  • The right invoice finance platform aggregates the right investors that are reliable and accredited and ready to provide quick funding. 

  • It provides a more flexible and affordable option than a traditional loan which allows your business to grow even in financially challenging times. 

  • It helps to bring together businesses willing to sell their accounts receivables to investors ready to advance funds.

With the above pros and cons of bill discounting in mind, businesses can opt for this method of business finance. It helps you to use your cash smartly and keeps the company free from any lending pitfalls arising on account of loans. Overall, invoice discounting platforms help to strengthen your business operations by financing your invoices and facilitate your business growth.

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Sanjana Mehta I am Sanjana Mehta, an Insurance Advisor.
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