Invoice discounting is a popular form of financing that enables businesses to raise funds quickly by using their unpaid invoices as collateral. In India, invoice discounting has become increasingly popular among small and medium-sized enterprises (SMEs) as a means to improve cash flow and meet their working capital requirements.
In this blog, we will explore what invoice discounting is, how it works in India, the benefits and drawbacks, and the future of invoice discounting in India.
What is invoice discounting?
Invoice discounting is a type of short-term financing that allows businesses to get an advance on their outstanding invoices from a lender, typically a bank or a financial institution. The lender buys the unpaid invoices at a discounted rate, providing the business with immediate cash flow, while the lender waits for the invoice to be paid by the customer.
In other words, instead of waiting for the customer to pay the invoice, the business gets paid upfront, albeit at a discounted rate. Once the invoice is paid, the lender recovers the full amount of the invoice, and the difference between the discounted rate and the full amount is the lender’s profit.
How does invoice discounting work in India?
In India, invoice discounting is typically offered by banks and non-banking financial companies (NBFCs) to SMEs. The process of invoice discounting in India typically involves the following steps:
- The business sells its goods or services to its customers on credit and issues an invoice for payment at a later date.
- The business then approaches a bank or NBFC to finance its unpaid invoices. The lender reviews the invoices and the creditworthiness of the business and approves a credit limit.
- The lender then offers to advance a percentage of the total value of the invoice, typically around 80-90%. The actual percentage may vary depending on the creditworthiness of the business and the lender’s policies.
- The lender takes ownership of the invoice and the right to collect payment from the customer.
- The customer pays the full amount of the invoice directly to the lender.
- Once the invoice is paid, the lender recovers the full amount of the invoice, minus the discount fee and any other fees charged by the lender.
Benefits of invoice discounting in India
- Improves cash flow: One of the primary benefits of invoice discounting is that it improves the cash flow of businesses. By getting paid upfront, businesses can use the funds to pay for expenses, invest in growth, or pay off existing debt.
- No collateral required: Invoice discounting does not require businesses to provide collateral, such as property or assets, to secure the financing. The unpaid invoices serve as collateral, which means that businesses can access financing even if they do not have substantial assets.
- Quick access to funds: Invoice discounting provides businesses with quick access to funds, usually within a few days of submitting the invoices for financing. This can be particularly useful for businesses that need funds urgently to meet their working capital requirements.
- Flexible financing: Invoice discounting is a flexible form of financing that allows businesses to access funds as and when needed. Businesses can choose which invoices to finance, depending on their cash flow needs, and the amount of funding can be adjusted according to the volume of invoices.
Drawbacks of invoice discounting in India
1. High-interest rates: Invoice discounting is a form of short-term financing, which means that it usually comes with higher interest rates compared to long-term loans. This can make it expensive for businesses, particularly those with lower profit margins.
- Limited financing: The amount of financing available through invoice discounting is limited by the value of the unpaid invoices. This means that businesses may not be able to access sufficient funds if they have a limited number of invoices or if their invoices have limited value.
- Loss of control: When businesses opt for invoice discounting, they are essentially selling their invoices to the lender. This means that they lose control over the collection process and may not be able to maintain their customer relationships. This can be a concern for businesses that value their customer relationships.
- Risk of non-payment: Invoice discounting is not without risks. If the customer fails to pay the invoice, the lender may require the business to repay the amount advanced, which can be a significant financial burden. This risk can be mitigated by choosing reputable lenders and thoroughly assessing the creditworthiness of the customers before issuing invoices.
The future of invoice discounting in India
Invoice discounting is a growing industry in India, driven by the increasing demand for short-term financing among SMEs. According to a report by the International Finance Corporation (IFC), the market for invoice discounting in India is expected to reach $58 billion by 2021.
The Indian government has also taken several initiatives to promote invoice discounting and ease the funding challenges faced by SMEs. In 2019, the Reserve Bank of India (RBI) issued guidelines for the operation of the Trade Receivables Discounting System (TReDS), an electronic platform that allows SMEs to auction their invoices to multiple lenders.
The TReDS platform has gained popularity among SMEs as it provides them with access to multiple lenders, thereby increasing competition and reducing financing costs. The platform has also helped to address some of the concerns related to invoice discounting, such as the risk of non-payment and loss of control over the collection process.
Conclusion
Invoice discounting is a useful financing tool that can help SMEs to manage their cash flow and meet their working capital requirements. However, it is important to carefully assess the pros and cons of invoice discounting before opting for it. Businesses should choose reputable lenders, thoroughly assess the creditworthiness of their customers, and negotiate favorable terms and interest rates.
In conclusion, the future of invoice discounting in India looks promising, with the government’s initiatives and the growing demand for short-term financing among SMEs. By using innovative financing solutions such as TReDS, businesses can access quick and flexible financing while also mitigating the risks associated with invoice discounting.
