Invoice factoring, sometimes also called invoice discounting, is a financial transaction in which a company sells invoices of their debtors to another firm and receives immediate payment minus a fee for the service (or discount). It is effectively a means of receiving payment before invoices are due and provide a company with working capital in the form of cash advances on money that is due from their customers rather than waiting for customers to pay (which can take up to 3 months depending on the payment terms).
This practice has become a major source for Confidential invoice discounting working capital for companies and has occurred as a response to the tightening of lending to businesses by banks. It is also attractive as an alternative source of financing for banks because they can lend based on the collateral of the invoices payable by a company’s debtors. This allows banks to move away from unsecured loans and overdrafts which have the risk of a company defaulting on its payments.
There are various types of this service:
• Confidential Invoice Discounting
In this type of invoice financing, the service is provided confidentially which means that neither the customer of the company nor its suppliers are aware that the company is being advanced money based on invoices for which payment is yet to be made.
• Invoice Discounting With Funding Limits
In some cases, providers of invoice financing do not undertake an assessment of the individual debtors to a company and their ability or likelihood of paying their invoices. Instead, they protect themselves against the possible insolvency of individual debtors by relying on a larger number of customers of the company. In some cases, they also insist that a single customer cannot be responsible for a given percentage of a company’s invoices.
• Whole Turnover Invoice Discounting
In this approach to every invoice owed to the company is sold to the finance provider regardless of the company’s need for funds.
Confidential invoice discounting is most often used by larger companies that are operating in a business-to-business sales environment and that issue invoices that are subject to between 30 and 90 days payment terms. Confidentiality is assured because debtors pay into a trust account that is established in the company’s name. Service fees are applied by providers of this type of service and they receive a percentage of the amount of the invoice (the discount fee) which represents the cost of borrowing the money from the provider.
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