Q. Explain about Invoice discounting?
Invoice discounting is a technique which is able to be used to raise finance against receivables.
Invoice discounting works as follows: A company issues an invoice to a customer as well as sends a copy invoice to the discount company which then makes a payment against the invoice and takes responsibility for collecting the debt from the customer. The amount of the payment will differ but is very rarely 100% of the invoice value. The balance of money unpaid is paid across to the selling company when the discount company has received full payment for the customer.
The arrangement has the effect of permitting the selling company to collect its debts in early so reducing the working capital requirement of the business and improving the cash flow.
The price that is paid for the service is typically set at a fixed percentage monthly rate for example 1% of the value of invoices discounted. Although the process operates "with recourse", companies will frequently find that they are only able to discount the invoices of customers with high credit ratings who are therefore reliable receivables. This means that not all invoices are able to be funded and the risk of bad debts remains. The extent to which companies may find that using invoice discounting does improve the cash flow is thus dependent upon the credit profile of customers and their bad debt record. The discounting is mainly advantageous (in cash flow terms) for companies which are selling to customers with high credit ratings and a good payment record.