As a commercial document, an invoice depicts the information about product or services sold on cash/credit, along with the terms of the deal and method of payment. An enterprise can finance invoices in two distinct ways. It can finance an invoice either through cash sales or as receivables. Invoice discounting, as an asset-based loan, enables enterprises to raise credit by using receivables as collateral. There are a number of financial institutions who help business owners to improve cash flow situation and raise working capital by extending term loans or line of credit against unpaid invoices. Invoice discounting is also popularly known as bill discounting.
Understanding Important Aspects of Invoice Discounting
Asset Based Loan
A business owner can avail invoice discounting just like other asset-based loans. But he needs to secure the term loan or line of credit through accounts receivables. Hence, the amount of the loan or line credit varies account to the amount of invoices used as collaterals. There are a number of financial institutions that advance funds to both start-ups and existing businesses against unpaid invoices.
Types of Invoice Financing
An enterprise can avail credit through various types of invoice financing. There are a number of lenders who provide cash advance or line of credit to businesses as a percentage of the value of multiple invoices. At the same time, certain financial institutions also provide cash advance or term loan against selected invoice. Hence, a borrower has option to discount multiple invoices according to his working capital requirements and cash flow situation.
Invoice Discounting Process
A business owner can avail this asset based loan simply by sending invoice details to the lender. The lender will evaluate the invoice details and pay a percentage of the invoice value as a term loan or line of credit. Most lenders allow business owners to borrow 80% of the face value of the invoices. Once the invoice is due, the lender collects the payment from the customer, and pays remainder of the invoice to the borrower after deducting his service fee. Hence, an entrepreneur can raise finance by discounting invoices just like conventional line of credit.
Most lenders lend money to creditors against value of unpaid invoices. But most lenders assess the eligibility of the lender based on a number of parameters while processing the asset based loan. The eligibility criterions differ from lender to another. Also, the eligibility criterion differs from start-ups and existing businesses. While discounting the invoices of an existing business, the lender considers its annual turnover, age, and CIBIL score. But the lender while discounting invoices of start-up considers if the business is already earning profits or about the break even.
Advantages of Invoice Discounts
Unlike other asset based loans, invoice discounting enables entrepreneurs to raise finance by using unpaid invoices as collateral. Hence, it becomes easier for business owners to raise working capital without increasing liability or taking additional loans. Also, most lenders provide cash advance to business owners against invoices within 48 hours. Hence, it becomes easier for the entrepreneur to accelerate and improve cash flow situation. At the same time, the business owner can avail the short-term credit without informing customers about pledging their invoices.
Suitability for Businesses
Each enterprise has option to choose from several long-term and short-term business loans. Hence, the business owner must keep in mind some important factors when he opts for invoice discounting. He needs to decide the exact invoices to be pledged to raise a certain amount of funds. Likewise, he needs to sustain customer relationship by managing credit control and collection on his own. It is also important to collect payment from customers on time to honour the terms of credit.
There are a number of invoice financers who emphasize on tri-partite agreement. The tri-partite agreement involves three parties – lender, borrower, and customer. The terms of the agreement ensures that the customer makes payment to the lender directly on the due date of the invoice. The agreement further shifts the credit collection from the borrower to the lender. A business owner can sign the agreement to raise short-term finance without collecting invoices.
On the whole, invoice discounting, as a short-term asset based loan, helps business owners to meet working capital needs and improve cash flow situation. An entrepreneur can opt for the financing from bill discounting companies to raise funds without taking expensive business loans or pledging valuable business assets. But the entrepreneur still needs to evaluate the pros and cons of invoice discounting according to his specific financial needs.