Invoice Discounting and Finance - How does it work?

7 August 2017

Invoice Discounting or Invoice Finance

Invoice discounting is a process where the company can raise money by selling its invoices to its customers, to a funder or bank. For example, if you are a manufacturer and you raise invoices to companies for your products, or you are a professional services firm, then these invoices can be sold to and funded by an invoice discounting company.

The lender will look at the invoices, the customer base and your business and decide how much to lend to your company or business based on the quality of their risk.

Usually if you have a business insuring regular invoices to other businesses you will find that they can lend you up to 90% of the value of those invoices. Typically though, 75% to 80% is the norm.

Once your company signs up for a facility like this it does NOT have to disclose to its customers that it has sold (assigned) its debts to the CID company. Hence the term CONFIDENTIAL INVOICE DISCOUNTING.
So, your customers will generally never know the debt has been purchased by a invoice finance company. You would send out a letter to them (provided by the funder) to say that they have to pay to a different bank account. Usually though that process is quite easy to get set up.

The invoice finance company will set up that new bank account in your company’s name to collect customer payments. This account will not be under your company’s control but it acts as a receptacle to “catch” payments.

Then the funder will allow you to “draw down” those funds when cleared. Each week or month, the factor will calculate how much your company has borrowed and charge according to the contract you agreed when setting up the facility. 

Advantages of Invoice Discounting

  • If you were to issue an invoice for £2,000 plus VAT (£2,400) you could then sell this invoice to an invoice finance company for 75% of the value of £2,400 which is £1,800. You can often draw this money down the DAY YOUR INVOICE is passed to them. This is great for cashflow. Especially if your customer normally takes 75 days to pay!
  • When your customer pays the bill in say 60-75 days, the money will be received into that special bank account set up by the funder. Typically the other 25% that is outstanding is paid to you upon receipt. Less any charges and interest.
  • This can be a very efficient way of raising money but it normally requires the company (or other business like a sole trader /partnerships) to sell all of company’s invoices to the factor.
  • Some funders like Marketinvoice may buy single invoices if they’re quite large
  • Your company will continue to manage the debtor book and collect out payments.
  • It is relatively inexpensive.
  • It is very quick and straightforward to set up if you have reasonable accounting information.

A quarterly audit will be carried out by the funder's staff to check that everything is in order.

Disadvantages of Invoice Discounting

  • If your company only has one or two customers then finance can be difficult to arrange because of what is called concentration issues. This is because too much concentration in one customer can mean that the finance company cannot get adequate insurance cover or its own credit risk is too high.
  • It does cost money and charges vary according to your businesses customers, the size of the invoices etc.
  • Directors or partners will have to provide ongoing financial information on a regular basis to the CID company. 
  • The funder will normally require 3 monthly or 6 monthly on site audits too. You may need to provide a personal guarantee  or indemnity to the lender.
  • If your customers pay later than 85 days it probably will not be a good product for your company

Conclusion

Invoice discounting (CID) is an excellent product for businesses that produce goods or services and issue regular invoices to their customers. It can help the company grow, it is relatively inexpensive and the risk is relatively low.

You may be required to provide an indemnity  or personal guarantee to the CID company, this means that you will adhere to the rules and not issue false invoices for example. That's basically fraud!
CID is not suitable for property development companies and it isn't that easy to obtain for the construction sector. BUT! We have contacts with funders that love the construction sector and  new products are being introduced all the time. 

We have partnered with Company Funding Options that has access to hundreds of different providers of finance so call on 020 7760 7524 if you want to know more

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