What is invoice discounting and how it works for SMEs?

What is invoice discounting and how it works for SMEs?

Oct 25, 2023

Girish Khurana

Invoice discounting is a financial arrangement where a business sells its unpaid invoices to a lender at a discount for immediate cash flow

Invoice discounting is a financial arrangement where a business sells its unpaid invoices to a lender at a discount for immediate cash flow

The SME enters into an agreement with a financial institution or a factoring company

This agreement outlines the terms and conditions of the invoice discounting arrangement, including the discount rate, fee structure, and the maximum amount of invoices that can be discounted

When the SME has eligible invoices, they can submit them to the financial institution or factoring company. Eligible invoices are typically those that are due for payment in the short to medium term, often within 30 to 90 days

The financial institution reviews the submitted invoices and verifies the authenticity and creditworthiness of the SME's customers

Once approved, the financial institution offers the SME a certain percentage of the invoice's face value upfront, known as the "advance rate"

The financial institution provides the SME with the agreed-upon funds, typically covering a significant portion of the invoice's value, minus a discount

The discount is the cost of financing, and it is calculated based on the interest rate and fees specified in the agreement

When the invoice's due date arrives, the SME's customer makes the payment directly to the financial institution. The financial institution deducts the outstanding invoice amount from the reserve, along with any additional fees and interest

Once the payment is received and any associated fees and interest are deducted, the remaining portion of the reserve is released to the SME. This amount effectively represents the remaining invoice value, minus the initial advance and financing costs

Image: Pexels