Invoice discounting has a dual purpose. First it benefits the customer allowing them to take a discount off the total amount of their invoice and second it allows a company to draw money against its own accounts receivables. It is therefore a form of short-term borrowing for a company in order for the company to be able to improve their cash flow and draw additional working capital from the business.

To accomplish this, the company borrows a percentage of the value of its accounts receivables (a ledger showing all customer’s owing money to the company). The accounts receivable report (also called the aging report) is broken down into columns of time (current customer’s, 30 day past due customer’s, 60 day, 90 day and 120 days and over customer’s). It is imperative that if the company wishes to borrow against its own accounts receivables, it ensures that the majority of customer’s remain in the current column. They do this by offering a discount to the customer if they pay their invoice within a certain date generally specified in the terms of agreement when the customer first did business with the company. Standard terms include: 2% 10th Net 30 days (meaning if the customer pays by the 10th of the month they can discount the amount owed on the invoice by 2%) 1% 10days Net 30 (means that the customer in order to take the discount of 2% must pay their invoice within 10 days). Most customer’s take advantage of the discounts offered by company’s.

The company uses the financial advantages of the discount to borrow from another financial institution. Its unpaid accounts receivables are used as collateral and another reason why it is important for the company to have as clean an accounts receivable report as possible. The business gets cash from the unpaid invoices increasing its financial position and repays to the financial institution interest only on the funds it borrows. The customer is unaware that the company is getting money on funds it has not received. They believe they are getting a bargain by being able to take a percentage off the amount they owe.

This type of business practice is done in most businesses which offer a discount in their terms of sale. Mainly commercial customers are offered these terms that include the discount option however, consumer’s are sometimes offered these types of terms as well. It is good policy for the business and the customer. In regards to the benefit to the customer in paying less, for their merchandise, it most often results in repeat business and that means a loyal customer base.

James enjoys learning about ways to help companies succeed. Companies often struggle with cash flows and discounting invoice appears to be a good solution. You can learn more about James at his accounting website ClockWork Accounting.