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FAQs on invoice discounting

By Annapoorna

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Updated on: Jul 26th, 2022

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4 min read

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Invoice discounting is a short-term financing source that is prominent among businesses globally. It is a useful mechanism for businesses to convert outstanding invoices into liquid cash. One can fund their working capital requirements by discounting outstanding invoices.

How does invoice discounting work?

Invoice discounting involves selling outstanding invoices to a third party at a discount. Invoices can also be discounted with the buyer, wherein the debtor advances the invoice value at a discount. At the time of maturity of the invoice, the seller or seller’s bank collects the invoice value from the buyer and repays the discounting entity.

Who provides invoice discounting services?

Generally, invoices are discounted with third parties, including banks, NBFCs and other financial institutions. Invoices are also discounted by the buyer who agrees to pay the invoice amount earlier at a mutually agreed discount.

Is invoice discounting a type of borrowing?

Invoice discounting is a short-term borrowing when advances are given against invoices. However, when invoices are discounted through an invoice discounting platform, it can’t be classified as borrowing as the payment is made to the creditor (vendor) by the debtor (buyer). Therefore, borrowings via invoice discounting do not appear in the balance sheet and are disclosed as accompanying notes in the financials.

How are discount and interest rates set?

The financial institutions set the discount and interest rates as per their lending terms. The rates are based on the tenure of the advance. The rates may range between 5%-8% p.a. When invoices are discounted via an invoice discounting platform, the buyer and the vendor mutually agree upon the rates.

What is the repayment period for invoice discounting?

The tenure is the credit period that the seller agreed with the buyer as per the terms of sale. The period gets over on the last date of the credit period of the invoice or on the date of payment of invoice value, whichever is earlier.

What are the types of invoice discounting?

Invoice discounting primarily consists of two types: Recourse and non-recourse. 

Recourse invoice discounting is where the discounting entity is provided security against any defaults in the discounting process. Hence, the seller is responsible in case of any default.

Non-recourse invoice discounting is where the discounting entity assumes full liability in case of default by the buyer. Hence, the buyer is fully responsible for any defaults. 

What are the advantages of invoice discounting?

Invoice discounting helps fuel working capital requirements. It helps convert funds trapped in the form of receivables into usable liquid funds. Hence, businesses need not wait until the credit period ends to realise the amounts.

What are the disadvantages of invoice discounting?

Invoice discounting places additional finance costs for the business and impacts profits. Over-reliance on invoice discounting can expose the business to higher costs and legal consequences. Invoice discounting is available only in the case of business-to-business invoices, which limits its scope for businesses that primarily sell to the general public.

Is credit rating important for obtaining finances through invoice discounting?

Like traditional finances, credit rating is checked during invoice discounting. In the case of non-recourse discounting, the finance depends on the buyer’s credit rating. The banker commonly checks the buyer’s CIBIL scores.

What is the TReDS platform?

Trade Receivables Discounting System (TReDS) is a platform mandated by the Reserve Bank of India. It is an electronic platform for invoice discounting for MSMEs. To be eligible for this scheme, one has to be registered as an MSME under the MSMED Act (Micro, Small and Medium Enterprises Development Act, 2006). This helps MSMEs discount their bills and obtain finances from banks, NBFCs and other financial institutions permitted by the Reserve Bank of India.

About the Author

I preach the words, “Learning never exhausts the mind.” An aspiring CA and a passionate content writer having 4+ years of hands-on experience in deciphering jargon in Indian GST, Income Tax, off late also into the much larger Indian finance ecosystem, I love curating content in various forms to the interest of tax professionals, and enterprises, both big and small. While not writing, you can catch me singing Shāstriya Sangeetha and tuning my violin ;). Read more

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