Advantages and Disadvantages of Invoice Discounting

Invoice discounting is a technique or a process by which a company can borrow cash from financial institutions on the basis of the invoices raised. In other words, invoice discounting is more of a short-term borrowing; where a company can draw cash against the invoices.

In Invoice discounting the company is liable to collect payments from its customers. Generally, a company can borrow up to 80% of the invoice amount within 24 hours. The actual percentage and duration may vary with different finance institutions and banks. This is very widely used by companies for immediate cash requirements and is one of the working capital sources.

It is important to know the advantages and disadvantages of the Invoice discounting technique in order to use it effectively.

Advantages of Invoice Discounting

Quick Cash

Invoice discounting is comparatively quicker and faster method to procure cash than applying for a Cash Credit in which credit institutions or banks take quite a lot of time in credit appraisal of the borrower.

Releases Locked Cash

Invoice discounting releases cash that has been locked in customer invoices for a long period of time. Invoice discounting converts the company’s account receivable (debtors) into liquid cash. This may even be useful in cases or emergencies.

Improves Cash Flow

Invoice discounting provides improved cash flow since generally 80% of the advance invoice amount (receivable) can be converted into cash thereby aiding shorter working capital cycles.

No Asset as Collateral

Cash can be obtained without using any assets as collateral; only invoices to which customers are yet to pay are to be submitted for the transaction.

Allows More Room for Credit Sales

The company can choose to grow sales in terms of cash or credit. Sales that are on credit can be converted into cash quickly and the company need not bother much about the liquidity issue which comes with credit sales if invoice discounting process is in place.

Confidentiality

In the case of invoice discounting, confidentiality can be maintained by the discounting houses. The suppliers and customers need not know about the borrowings of the company against sales invoices.

Win-Win Situation in Business

The borrowing company can obtain the cash it needs whereas the customer can be given the credit period. This creates a win-win situation for the company and the company’s customer which in turn helps in building a healthy relationship with customers.

Disadvantages of Invoice Discounting

Decreases Profit Margins

The financial institutions providing invoice discounting generally charge a fee which becomes an additional cost to the company. This decreases the profit margins for the borrowing company.

People’s Perception

Some people perceive invoice discounting as a stigma over the company, hence, excessive reliance on invoice discounting may not be taken very positively by all stakeholders.

Only Commercial Invoices

The majority of financial institutions allow borrowing only on commercial invoices. If a company deals with general public then that company may not be eligible for invoice discounting.

Leniency in Credit Terms Affecting Productivity

Excessive usage of invoice discounting facility may cause management to be non-focussed on strengthening credit norms for debtors. The company should ideally be focussing on shorter credit periods and not invoice discounting as a mechanism to improve working capital cycles and liquidity.

Conclusion:

Invoice discounting is a quick method to improve cash flow and working capital cycle but one has to keep in mind that invoice discounting should be used as an additional facility and not as a regular process. The key focus should be on improving working capital cycle by bargaining efficiently with debtors to ensure quick payments.

References:

Last updated on : July 12th, 2017
What’s your view on this? Share it in comments below.

One Response

  1. Jack Oliver

Leave a Reply

Working Capital Loan and Finance
  • Permanent or Fixed Working Capital Graph
    Permanent or Fixed Working Capital
  • Advantages of Trade Credit
    Advantages of Trade Credit
  • Advantage of Negative Working Capital
    Advantages of Negative Working Capital
  • Objectives of Working Capital Management
    Objectives of Working Capital Management
  • Subscribe to Blog via Email

    Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Join 122 other subscribers

    Recent Posts

    Find us on Facebook


    Related pages


    dividend irrelevance theorycost of capital and waccifrs asset valuationfinance roccredit rationing definitioncapital budgeting techniques notesdisadvantages of investing in sharesincremental defdeterminant of dividend policyformula of operating leveragedebt to assets ratio calculatorzbb zero based budgetingformula for irrreceivables turnover ratio industry averagewhat is meant by payback periodwhat is the dupont equationinvestopedia budgetvariable growth model formulagaap software capitalizationturnover of accounts receivablestandby letter of credit vs letter of crediteps formula accountingdefine degree of operating leveragem&m share pricethe basics of capital budgetingsimilarities between domestic and international tradefixed versus variable costsdefinition of paybackzero base budgeting pdfcurrent account overdraft facilityhow is wacc calculateddiscount rate and waccdebit credit analysis exampleideal dscrdefinition of factoringmm hypothesis capital structure theoryoverdraft facilitiesissued subscribed and paid up capitalhow to calculate internal rate of returninterpolated rate calculationtotal debt to total asset ratiogaap software capitalizationlc at sight paymentdupont case analysisprocess costing meaningdividend relevance and irrelevance theoryexplain overdraftdiscounted payback period methodcalculating pre tax cost of debtaccounting ratio analysis interpretationrevaluation method ifrsdistinguish between pledge and hypothecationsight lc paymenthire purchase and leasing differencedefinition of payablescost of debenture formulagdr adrbudgeting techniqueforeign exchange exposure definitionadvantages and disadvantages of variable costingwac weighted average costdefine initial outlayapproaches to finance functionhindi meaning of expensesmeaning of debit and credit in hindizero balance budgetingwhat are the components of waccirr meaningliquidity ratios analysisdebenture interest ratevaluation using dcfcalculation of capital employed formulaadvantages of program budgetingmeaning of debit in accountingconvertible debentures meaningdays sales in receivables ratio analysiscalculate stock price based on dividends