Invoice discounting allows a business to draw money against its sales invoices before the customer has actually paid. To do this, the business borrows a percentage of the value of its sales ledger from a finance company, effectively using the unpaid sales invoices as collateral for the borrowing.

Although the end result is the same as for debt factoring (the business gets cash from its sales invoices earlier than it otherwise would) the financial arrangement is somewhat different.

When a business enters into an invoice discounting arrangement, the finance company will allow the business to draw down a percentage of the outstanding sales invoices - usually in the region of 80%. As customers pay their invoices, and new sales invoices are raised, the amount available to be advanced will change so that the maximum drawdown remains at 80% of the sales ledger.

The finance company will charge a monthly fee for the service, and interest on the amount borrowed against sales invoices. In addition, the finance company may refuse to lend against some invoices, for example if it believes the customer is a credit risk, sales to overseas companies, sales with very long credit terms, or very small value invoices. The lender will require a floating charge over the book debts (trade debtors) of the business as security for the funds it lends to the business under the invoice discounting arrangement.

Responsibility for raising sales invoices and for credit control stays with the business, and the finance company will often require regular reports on the sales ledger and the credit control process.

FactoringAccounts receivable