What is invoice discounting?

Intro: Invoice discounting is a form of invoice financing where a business uses unpaid invoices to access cash before the customer pays. The financing is tied to your accounts receivable, meaning it’s based on the money your customers already owe you.

It’s typically used for short-term cash flow rather than long-term growth. The business usually repays the financing once the customer pays the invoice. Keep in mind that fees or interest reduce the total amount you collect, so it’s not free money.

This guide walks you through how invoice discounting works, when it may make sense, and how it compares to invoice factoring. You’ll also learn practical ways to strengthen your cash flow before turning to outside financing.

How does invoice discounting work?

The process for using unpaid invoices to access cash flow is fairly straightforward. While the exact application, advance amount, repayment structure, and fees depend on the financing provider, invoice discounting typically follows these steps:

1. Send an invoice to your customer

First, you provide your product or service and send the customer an invoice as part of your normal billing process. The invoice will typically include agreed-upon payment terms, such as net 30, net 60, or net 90.

Rather than waiting until the end of that payment period to receive the cash, you may be able to use the outstanding invoice to access financing sooner.

2. Apply for financing using the unpaid invoice

Next, you apply with an invoice financing provider and identify the unpaid invoice or invoices you want to use for financing. The provider may review details such as the invoice amount, payment terms, and the customer responsible for paying it.

Eligibility requirements and approval processes vary, so not every invoice or customer will necessarily qualify.

3. Receive an advance on the invoice value

If approved, the provider advances you a portion of the invoice's value before your customer pays. Advance rates are often around 70% to 90%, although the actual percentage depends on the provider and financing agreement.

This gives your business access to some of the cash tied up in accounts receivable without waiting for the invoice's full payment term.

4. Your customer pays the invoice

Your customer then pays the invoice according to the original payment terms. Depending on how the financing arrangement is structured, the payment process may look similar to your normal invoicing process.

One distinction between invoice discounting and some other forms of invoice financing is that businesses can often continue managing their own customer relationships and collections.

5. Repay the financing provider and account for costs

Once the customer pays, you repay the financing provider for the amount advanced, along with any applicable fees or interest. The amount remaining after those financing costs is yours.

For example, say you have a $10,000 invoice due in 60 days. A financing provider may advance you a percentage of that $10,000 upfront, giving you access to cash before the due date. When your customer pays the full invoice, the advance and applicable financing costs are settled. Your actual advance amount, fees, interest, and repayment terms will depend on the provider and agreement.

Invoice discounting vs. invoice factoring

Invoice discounting and invoice factoring are both types of invoice financing. Both can help businesses access cash from unpaid invoices, but they work in different ways.

The biggest difference is usually control. With invoice discounting, your business may keep more control over customer communication and collections. With invoice factoring, the factoring company often takes over more of the collection process.

When invoice discounting may make sense

Invoice discounting is not right for every business. It tends to fit certain situations better than others.

You might consider invoice discounting when:

• Customers take 30, 60, or 90 days to pay.
• You have invoices from customers with strong payment histories.
• Expenses are due before invoice payments arrive.
• You need short-term working capital.
• You want financing tied to accounts receivable instead of a traditional loan.
• You want to keep control of customer relationships and collections.

Invoice discounting may be more useful for businesses that sell to other businesses on credit terms. It may be less useful if your customers pay upfront, if your invoices are hard to verify, or if payments are unpredictable.

Pros and cons of invoice discounting

Like any financing option, invoice discounting has trade-offs. Here’s a side-by-side look:

Pros

Invoice discounting can help you access cash faster than waiting for a full invoice payment cycle. That can be helpful when you need to run payroll, buy inventory, pay vendors, or manage other short-term expenses.

It may also scale with your sales. As you send more eligible invoices, you may have more receivables available to support financing.

Because your business may continue managing customer communication, invoice discounting can also be less disruptive to customer relationships than some other financing options.

Cons

The main downside is cost. Fees or interest reduce how much you keep from each invoice.

Invoice discounting also depends on invoice quality. Providers may review the customer, invoice amount, payment terms, and likelihood of payment before approving financing.

Customer nonpayment can also create problems. In many arrangements, your business is still responsible for repayment if the customer doesn’t pay. Terms vary by provider, so review the agreement carefully before signing.

Alternatives to invoice discounting

Invoice discounting is just one way to manage cash flow. Depending on your situation, another option may be a better fit. Here are a few alternatives to consider:

Many businesses combine a few of these. Sometimes, a few small process changes can close the gap without any outside financing.

How to improve cash flow before considering invoice discounting

Before you turn to financing, it helps to tighten up your billing. Small changes can speed up payments and reduce the need for outside cash.

Here’s what you can do:

Send invoices promptly

Send invoices as soon as work is complete or according to the schedule in your customer agreement. Delayed invoices can lead to delayed payments.

Use clear payment terms

Make sure each invoice shows when payment is due, what payment methods you accept, and whether late fees or discounts apply. Clear terms can reduce back-and-forth with customers.

Use an invoice generator

An invoice generator can help you create clearer, more consistent invoices. This can make it easier for customers to understand what they owe and when payment is due.

Offer online payment options

The easier it is to pay, the faster some customers may act. Online invoice payments can give customers a simple way to pay without mailing checks or requesting extra instructions.

Track unpaid invoices weekly

Review unpaid invoices regularly so overdue balances don’t go unnoticed. Weekly tracking can help you spot slow-paying customers and follow up sooner.

Send automatic reminders

Sending payment reminders can help you follow up without manually tracking every due date. This can be especially helpful if you manage many customers or recurring invoices.

Use recurring invoices for repeat customers

Recurring invoices can help you automate billing for customers who pay on a regular schedule. This can save time and reduce missed billing cycles.

Review customer payment patterns

Look at which customers pay on time, which customers pay late, and which invoices take the longest to collect. These patterns can help you decide whether to adjust terms, ask for deposits, or consider financing.

Watch for invoicing mistakes

Avoiding common invoicing mistakes, like inconsistent invoice numbers or missing payment terms, can also help you get paid faster and keep clean records.

How QuickBooks can help with invoicing and cash flow visibility

Invoice discounting may help some businesses manage short-term cash flow, but it’s not the only option. Better invoicing habits and stronger visibility into unpaid invoices may help you close cash flow gaps before turning to financing.

If you're just starting out, QuickBooks Free accounting software can give you a simple way to manage key financial tasks without a monthly subscription. You can use it to send invoices, track income and expenses, and keep your records organized, helping you build better visibility into the money coming in and going out of your business.

As your needs grow, QuickBooks invoicing and billing software can help you create and send invoices, accept payments, track invoice status, follow up on unpaid invoices, and keep financial records organized. With clearer invoice tracking, you can see which customers owe you money, when payments are due, and how unpaid invoices may affect your cash flow.

Explore QuickBooks invoicing software to turn unpaid invoices into clearer cash flow insights.