What is invoice discounting?

How lenders use it

An invoice discounter lends against the quality of the sales ledger. The credit team reads the aged debtors report and looks at who owes the money, how old the invoices are and how much one customer makes up. It then sets an advance rate and a limit for each customer.

The lender checks three things closely. One is concentration, which is the share of the ledger owed by one customer. Another is dilution, which is the value lost to credit notes, discounts and returns. The third is whether the invoices are real. Many lenders verify a sample with the customers or check delivery documents.

The business signs an assignment of its invoices to the lender. The lender then checks the Companies House charges register. Another lender may already have a charge over the debtors. If so, the two lenders usually need a deed of priority before funding starts.

Recourse and non-recourse are the two main options. With recourse, the business must repay the lender if a customer does not pay. With non-recourse, the provider takes the loss for approved customers up to a limit, but usually only when the customer cannot pay. It does not cover disputes. Non-recourse costs more.

Worked example

Example only. A business has £100,000 of approved invoices. The advance rate is 85%, so the lender pays £85,000 up front. The business collects £100,000 from its customers in about 60 days.

The lender takes back its £85,000. It keeps a service fee of 0.5% of the invoices, which is £500. It also keeps a charge on the money advanced, about £350 at 2.5% a year for 60 days. The business receives the rest, about £14,150. The rates here are made up.

Common confusions

Invoice discounting is not factoring. In discounting, the business collects from its customers and the arrangement is usually confidential. In factoring, the provider runs the ledger and collects, and customers know.

Invoice finance is the umbrella term. It covers both factoring and discounting. Some lenders also offer selective finance on single invoices.

Non-recourse is not full protection. It usually covers only a customer that becomes insolvent or does not pay by a set date. Cover is limited to the approved credit limit, and a disputed invoice is excluded.

Questions lenders ask

What is the difference between factoring and invoice discounting?

In factoring, the provider takes over the sales ledger, collects from customers and the customers know. In invoice discounting, the business collects itself and customers usually do not know. Discounting suits larger or more established businesses.

What is recourse and non-recourse in invoice finance?

With recourse, the business repays the lender if a customer does not pay. With non-recourse, the provider takes the loss on approved customers up to a limit, but only for set causes such as insolvency. It costs more and excludes disputes.

What documents does an invoice finance lender ask for?

Usually the aged debtors report, recent accounts and management accounts. Also a sample of invoices and the terms with the main customers. It also asks about existing charges and loans. The document checklist tool lists the common items.

How much of an invoice does a lender advance?

Often 80% to 90% of the approved invoice value. The lender sets the rate by the quality of the ledger and the business. It holds the rest as a reserve until the customer pays.

Aged debtors report: Who owes the business money, and for how long
Debenture: Security over a company's assets
Working capital loan: Short-term funding for day-to-day costs
Cash flow lending: Lending against earnings, not against assets

This page is general information for lenders. It is not legal, tax or credit advice.