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Invoice discounting is a type of business financing option that makes use of customer invoices to receive some type of cash flow before customers actually pay those invoices. Similar to the process of invoice factoring, invoice discounting is a short-term borrowing situation that allows a business to draw funds against those invoices, then repay the balance when payments on those invoices are received. Unlike most debt factoring arrangements, invoice discounting does not necessarily involve entering into a long-term commitment with the lender, making this option ideal when a company needs some help with cash flow for a relatively short period of time.
With invoice factoring, a company identifies specific invoices that are presented to the lender. The lender can assess those invoices, often in terms of the payment history of the company’s client and the total face value of that invoice. If approved, the lender will allow the company to draw a percentage of that face value, usually no more than 80%. The company forwards the invoice to the customer, who in turn pays the invoice according to terms. Once the payment is received, the company repays the lender the total amount drawn, plus interest and a monthly fee associated with providing the advance.
One of the chief advantages of an invoice discounting approach is that the company can select specific invoices to present to the lender, rather than submitting the entire batch of invoices generated for a given period. This approach makes it easier for the company to assess its needs for immediate cash flow, select invoice issued to customers who consistently remit payment within 30 days or less, and use only those for the advance. The company remains in control of the invoicing process and even continues to manage collection efforts if necessary, an arrangement that is not usually the case when working with a factoring service.
Another benefit to the company that chooses to go with invoice discounting is that the customers are not required to change anything in the way they remit payments. With factoring arrangements, the lender normally requires the establishment of a lockbox and a change in the remittance address so those customer payments go directly to the lender. Factoring services also assume control of the collections process, which can sometimes damage customer relations and result in a loss of business. Since the invoice discounting approach usually does not introduce a third party into the communications between the company and its customers, this method of expediting cash flow is truly transparent and has very little chance of impacting relationships with valued customers.