What is invoice discounting and how does it work?

If your business needs a quick cash injection, invoice discounting could be worth exploring. This guide explains how it works.

Key takeaways

• Invoice discounting lets you borrow up to 95% of the value of your unpaid invoices in advance

• You collect customer invoice payments as normal, so your clients don’t know you’re borrowing

• Invoice discounting is often cheaper than invoice factoring, but still involves fees

• It’s best suited to large B2B companies with a robust trading history

What is invoice discounting?

Invoice discounting is a type of invoice finance that gives you access to up to 95% of the value of your customer invoices in advance. The borrowed funds usually arrive in your bank account within a day or two, which means you can use the money you’ve earned without waiting for your customers to pay their invoices.

This method of business finance can help maintain a healthy cash flow, cover unexpected expenses or expand your premises. 

How does invoice discounting work?

Invoice discounting works by using your unpaid customer invoices as collateral to secure a loan from a provider. The process works as follows:

1. You sell goods or services to your customers as normal

2. You invoice your customers and send the invoices to an invoice discounting provider

3. The provider lends you a portion of the value of the invoices (usually between 80% and 95%) within 24 to 48 hours

4. Your customers pay you as usual – you are responsible for chasing any late payments

5. Once your customers have paid, you repay the loan to the invoice discounting provider, retaining the portion of the invoices that wasn’t covered in the agreement, minus the lender’s fees 

In some cases, your customers might pay directly into a trust account in your business’s name but controlled by the invoice discounting company. In this situation, the lender releases the remaining balance to you, minus fees, once your customers have paid.

Invoice discounting example

Your company sells customer invoices worth £10,000 to an invoice discounting company in exchange for 80% of the value (£8,000).

You collect the full £10,000 payment from your customers and keep the remaining 20% balance (£2,000) from which you deduct £500 in fees. You pay back £8,500 to the invoice discounting provider.

Read more:

• What is business finance? 

• How to get funding for a business

• Types of business loans explained

Advantages and disadvantages of invoice discounting

Before deciding whether invoice discounting is right for your business, be sure to weigh up the pros and cons. 

Pros

• Fast access to funds – You usually receive the funds within 24 to 48 hours instead of the 30 to 90 days it can take for customers to pay you

• Easier approval – Invoice discounting is generally easier to qualify for than traditional business loans

• No additional collateral needed – Your invoices act as security, so you won’t need to provide any further collateral

• Confidentiality – Because your business collects the invoice payments, your customers don’t know you’re borrowing

• Lower fees than invoice factoring – Invoice discounting typically has lower fees than invoice factoring, as you handle payment collection 

Cons

• Contract length – You may have to tie into a contract of one or two years

• Fees – Although fees are lower than invoice factoring, costs can be higher compared to other sources of business funding. You may have to pay discounting, admin, and service fees 

• No support for chasing payments – Unlike invoice factoring, managing customer payments is your responsibility, which can be time-consuming

• You must vet customers – Invoice discounting providers don’t credit check your customers, so it’s up to you to assess their reliability 

What is the difference between invoice discounting and invoice factoring? 

Invoice discounting and invoice factoring both allow you to borrow against unpaid invoices, but the key difference is how invoice payments are collected.

With invoice discounting, your business remains responsible for collecting unpaid invoices, and customers won’t know you’re using a provider. 

By comparison, invoice factoring shifts responsibility to the provider, which chases the payments on your behalf. Once the provider has deducted its fees, it transfers the remaining balance to you. Since invoice factoring involves extra administration, it’s usually more expensive, and your customers will be aware of its use.

How much does invoice discounting cost?

The cost of invoice discounting varies depending on the provider, the number and value of your invoices, and your industry. However, expect to pay a discounting fee of between 1.5% and 3% of the total value of your invoices. 

You may also pay a service fee of around 0.2% to 0.5% of your annual turnover, plus an administration fee to set up the facility.

Is invoice discounting right for your business?

Invoice discounting typically suits B2B (business-to-business) companies better than B2C (business-to-consumer). But it could work for you if you regularly issue invoices with long payment terms (up to 90 days) and you’re looking for a quick and easy way to boost cash flow.

To qualify, businesses generally need a high annual turnover and robust trading history. Lenders prefer companies with a proven record of issuing and collecting invoices, along with a strong credit score. Smaller firms may find it harder to qualify.