Invoice discounting is a financial practice used by businesses to improve cash flow and access immediate funds by selling their accounts receivable (invoices) to a third-party financial institution, usually a bank or a specialized finance company. It is a form of short-term borrowing that allows a company to receive a portion of the money owed by its customers before the actual payment due date on the invoice.

Here’s how invoice discounting typically works:

1. Issuing Invoices: The business provides goods or services to its customers and generates invoices detailing the amount due and the payment terms.
2. Invoice Discounting Agreement: The business enters into an agreement with a financial institution that offers invoice discounting services. This agreement establishes the terms and conditions, including the discount rate, which determines how much the business will receive upfront.
3. Submission of Invoices: The business submits the invoices to the financial institution for verification. The financial institution evaluates the creditworthiness of the business’s customers and approves the invoices eligible for discounting.
4. Discounting Process: Once approved, the financial institution advances a certain percentage (usually around 70% to 90%) of the total invoice value to the business. The remaining percentage, minus the discount fee, is withheld and paid to the business after the customer pays the invoice on the due date.
5. Customer Payment: The business’s customers make payments directly to the financial institution on the invoice due date. The financial institution then releases the withheld amount to the business, minus the discount fee.
6. Repayment and Charges: The business is responsible for repaying the financial institution the amount advanced on the invoices, along with the agreed-upon discount fee, which is usually based on the time period the invoice remains outstanding.

Invoice discounting is different from factoring, another form of accounts receivable financing. In factoring, the business sells its invoices outright to the financial institution, which then takes over the responsibility of collecting payment from the customers. In contrast, with invoice discounting, the business retains control of the invoice collection process.

The main benefits of invoice discounting include improved cash flow, reduced reliance on long payment cycles, and the ability to reinvest the funds into the business immediately. However, it’s important to carefully consider the costs and terms associated with the service to ensure it aligns with the business’s financial needs and goals.