Is Invoice financing short-term or long-term?

With invoice financing, vendors can generate cash by taking payment of a service charge before the due date on the sale of their outstanding invoices. This is then used as collateral with a financing institution.

What is invoice financing?

Through invoice financing, a business can receive funds by pledging trade receivables as collateral. This allows for a quicker turnover of cash from the customers that the business may then put to use to carry on its day-to-day operations.

Classification of invoice discounting for financial reporting purpose

For invoice discounting to be termed as short-term or long-term, it is down to the type of invoice discounting arrangement that is in place in a particular scenario.

Confidential and Disclosed invoice discounting

Confidential invoice discounting

In this case, the customers will be unaware of the fact that the business is using a third-party finance provider. The business may prefer to operate under these terms so that the relationship between the customer and the business remains unaffected.

The statements containing outstanding balances, chasing letters, etc. will all be sent in the name of the business. The business may also opt to be in charge of the credit control function, thus enabling its own staff to act as credit controllers.

However, this type of invoice discounting is only offered to large companies that are well established and have a large turnover.

Example: Rahul Limited has invoiced Rakesh Enterprises for services previously rendered to them. The invoice amounted to Rs. 2,00,000. A copy of this invoice is sent by Rahul Limited to the financing company. The financing company pays Rahul Limited up to 95% of the invoice value within 24 hours. The discounting company will also maintain an account under the name of Rahul Limited.

While Rahul Limited has received most of the money, they will still have to follow up with Rakesh Enterprises regarding the payment. At the time of making the payment, the payment will be made to the account under the name of “Rahul Limited”. Rakesh Enterprises will be unaware of the fact that the payment is, in reality, being made to the discounting company.

Once the full payment is received, the outstanding balance of 5% is paid to Rahul Limited.

Disclosed invoice discounting

Here, the customers are made aware of the third-party financier arrangement from the start. A general notice is sent to the customers, notifying them of the involvement of the financier. Every invoice sent to the customer will also contain a notice of assignment, reminding the customers of the arrangement.

Example: Rahul Limited has invoiced Rakesh Enterprises for services previously rendered to them. The invoice amounted to Rs. 2,00,000. A copy of this invoice is sent by Rahul Limited to the financing company.

When Rahul Limited approaches the financing company regarding a financial arrangement, the details of the arrangement will be made known to Rakesh Enterprises. Moreover, the invoice will contain details regarding the arrangement made by Rahul Limited with the discounting company.

Therefore, at the time of making the payment, the payment will be made to the financing company directly. Rakesh Enterprises will be unaware of the fact that the payment is, in reality, being made to the financing company.

Recourse and Non Recourse invoice discounting

Recourse invoice discounting

Where the invoice remains unpaid beyond a specific as well as extended credit period, the business is liable to pay back the amount to the financier (invoice discounter). The amount to be paid back refers to the advance money paid by the financier at the time of invoice discounting.

Example: Rahul Limited has invoiced Rakesh Enterprises for services previously rendered to them. The invoice amounted to Rs. 2,00,000. A copy of this invoice is sent by Rahul Limited to the financing company. The credit period on offer is 30 days with an additional 15 days as an extended period.

The terms of the arrangement also specify that the advance amount given to Rahul Limited in exchange for the invoices will have to be repaid by them if the payment of the invoices is not fulfilled within the period specified. If Rakesh Enterprises does not make the payment within the 45 days specified (30 + 15 days), then the advance amount granted to Rahul Limited has to be repaid to the invoice discounting company.

Non Recourse invoice discounting

In this case, the lender (invoice discounter) has to bear the risk associated with non-payment of any invoices. If the invoice is not paid within the time period stipulated, the costs associated with the unpaid invoices will be borne by the lender itself.

This is why non-recourse invoice discounting is also known as protected invoice discounting. Since the level of risk taken on by the financier is relatively higher, the charges for this facility will also be on the higher side.

Example: Rahul Limited has invoiced Rakesh Enterprises for services previously rendered to them. The invoice amounted to Rs. 2,00,000. A copy of this invoice is sent by Rahul Limited to the financing company. The credit period on offer is 30 days with an additional 15 days as an extended period.

Example: Rahul Limited has invoiced Rakesh Enterprises for services previously rendered to them. The invoice amounted to Rs. 2,00,000. A copy of this invoice is sent by Rahul Limited to the financing company. The credit period on offer is 30 days with an additional 15 days as an extended period.

The terms of the arrangement also specify that the risk associated with non-payment of the dues will be borne in full by the invoice financing company. In exchange for bearing this risk, the financing company will take as high as 20% of the total amount towards its charges.