Selective Invoice Discounting: Meaning, Uses, Pros & Cons

Cash flow management is always a major concern for businesses. Untimely receipts from debtors may result in delayed payment to your creditors or funding your upcoming projects.

Earlier, we had debt factoring or financing where a company sells out its debt receivables to the finance provider, i.e. the ownership of debt is transferred. The finance provider will have the responsibility to collect the payment when due.

In this article, we will learn about selective invoice discounting, which works on the same approach as debt factoring but with a different context.

Meaning of Selective Invoice Discounting

Selective Invoice Discounting involves a company selling its invoices at a discount to raise immediate funds.

Invoice discounting may involve the selling of certain invoices or all invoices. This may depend on the terms of the finance provider (“the invoice discounter”).

Uses and Importance of Selective Invoice Discounting

Invoice discounting works on an “as and where” basis. That is, whenever you require immediate funds, just send the invoices to your finance provider; after their due diligence process, a percentage of funds (usually 95%) is remitted to you. There is no commitment or need to repeat this process monthly or quarterly.

Selective Invoice Discounting is very crucial for startups. Startups have low creditworthiness, especially in their initial stages. The creditors are willing to sell either on advance or immediate payment by these startups. Startups offer an extended credit period to their debtors to make sales.

Due to this condition, a startup’s payment and receipt cycles tend to be messed up. This is where invoice discounting serves as a saviour to manage the cash flows.

Pros and Cons of Selective Invoice Discounting for Businesses

The advantages are as follows:

As discussed earlier, selective invoice discounting works as an effective tool for raising working capital. Companies are free from approaching their banks for overdrafts or credit facilities.

For a loan application, an applicant must provide collateral, but only an unpaid invoice is required without any collateral support in the case of invoice discounting.

Under debt factoring, your debtors are given a notice that their debts have been sold off to the finance company. But invoice discounting does not involve this process; the company collects the final dues. This helps the company manage relations with its debtors.

There are certain disadvantages related to invoice discounting:

Invoice discounting is not available to all. There are predetermined net worth or turnover limits prescribed by the finance company. Hence, not every business can qualify for invoice discounting, especially small companies.

The invoices are selected based on the creditworthiness of the debtors. Finance won’t be available for every invoice or debtor.

The discounting or finance charges vary from industry to industry or even on the debtor’s creditworthiness. It can be a huge cost for your business, affecting its profitability. So, the programme’s cost must be evaluated against the cost of alternative sources of financing the working capital. One may identify that some invoice discounting models are relatively cheaper as well.

The company will repay the loan irrespective of whether your debtor pays up on time or not. This may double the burden of businesses to manage their cash flows.

Selective Invoice Discounting is a very attractive tool for managing cash flows, but the option should be exercised with caution. Also, the terms must be closely evaluated so that the company uses the right invoice discounting product. A business must make informed decisions before availing any sort of finance.