What Is Invoice Discounting?

Invoice Discounting:

Invoice discounting is a financial arrangement where a business sells its accounts
receivable (unpaid invoices) to a third party, typically a financial institution or a specialized
company known as a factor, at a discount. This allows the business to receive immediate
cash flow instead of waiting for customers to pay their invoices.

  • Business: This represents the company that has provided goods or services to its
    customers and generated invoices for payment.
  • Invoices (Unpaid): These are the invoices that the business has issued to its
    customers, but the customers haven’t paid them yet. The business is waiting for
    these payments to come in.
  • Financial Institution: This could be a bank, a financing company, or a specialized
    factoring company. They provide funds to the business based on the value of the
    unpaid invoices.
  • Invoice Discount: This arrow represents the process of selling the unpaid invoices
    to the financial institution at a discount. The discount is typically a percentage of the
    total invoice value. In return, the business receives immediate cash from the
    financial institution.

The financial institution will then collect the full payment from the customers when the
invoices become due. The difference between the discount given to the business and the
actual payment collected from the customers becomes the financial institution’s profit.

Remember that the actual process might involve legal agreements, terms, and conditions
between the business and the financial institution. The diagram is a simplified
representation to convey the concept.