What is invoice discounting and how does it differ from factoring?
Invoice discounting is a form of receivables financing where a business borrows money against its outstanding unpaid invoices. Unlike factoring, the business retains responsibility for collecting payments from customers and the financing arrangement is typically confidential to customers. The finance provider advances a percentage of the invoice face value; the business repays when customers pay. Invoice discounting is a short-term working capital facility, not a sales of receivables.
How does the invoice discounting facility work?
Invoice discounting mechanics: (1) Eligible invoices (meeting age, value, and quality criteria) are assigned to the finance provider as security; (2) Finance provider advances 80-90 percent of face value to the business; (3) The business continues to collect from customers in its own name; (4) When customers pay, the funds are remitted to a trust account controlled by the finance provider; (5) The balance (10-20 percent less fees and interest) is released to the business. The facility is a revolving line against the receivables ledger.
Frequently Asked Questions
- What is the difference between invoice discounting and an overdraft?
- An overdraft is a generic credit facility not linked to specific assets. Invoice discounting is an asset-based facility secured on the receivables ledger. As invoices increase, the available facility increases. As invoices are paid, the facility reduces. This makes invoice discounting more flexible and self-funding than an overdraft for growing businesses. Invoice discounting rates are typically lower than overdraft rates for creditworthy businesses because the receivables provide security.
- How does VAT interact with invoice discounting?
- VAT is not affected by invoice discounting because the supply, the tax point, and the VAT liability all arise when the invoice is issued to the customer, not when financing occurs. The business still remits VAT to the tax authority based on invoices issued regardless of whether they have been discounted. The finance provider's fee (interest and service charge) is a financial service that may be VAT-exempt.
Related Concepts
- What is supply chain finance and how does it use invoice data?
- What is invoice financing and what are the main types?
- What is bad debt relief for VAT and how is it claimed?
- What is the accounts receivable cycle and how does e-invoicing accelerate it?
- What is dynamic discounting and how does it relate to invoice processing?