What is Invoice Discounting?

Imagine an investment which is not linked to the Stock market but still delivers an 11-12% return.

Well.... Invoice discounting is one such investment opportunity

Invoice discounting is?when a business sells an invoice to a third party at a discounted price.

For Example.

ABC Plastic Ltd is a small company that makes plastic wrappers for biscuits and other food items

So, On one fine day, Brittania, A major FMCG company, comes to ABC Plastic Ltd and says hey, We need 10L worth of wrappers.

ABC plastic ltd is extremely happy that they got a big order from a famous company, but

Brittania says, Hey, listen, We need the wrappers right away, but you need to give us a credit period of 90 Days, and we will pay back in time.

But of course, ABC needs money to carry out day-to-day operational activities and pay the salary of its employees.

Now ABC has three options to come up with the money

One, They can refuse to give a credit period, but in that case, some other company with enough cash in their reserves will get the order which is not so good for ABC plastic Ltd.

Two, They can go to the Bank and get a loan, but they will have to pay lots of interest which might affect their profitability

and the final option is Invoice discounting.

Waiting for customers to pay invoices can put a strain on small-to-medium-sized businesses’ cash flow. That’s where invoice discounting comes in.?

Invoice discounting enables businesses to?gain instant access to cash tied up in unpaid invoices and tap into the value of their sales ledger. It’s simple: when you invoice a customer or client, you receive a percentage of the total from the lender, providing your business with a cash flow boost.?

So, ABC Plastic Ltd can get the receipt they received from Brittania for 10Lakh and go to an investor who will pay them 9 Lakh (which is a 10% discount on the original invoice) rupees right away, and he can claim 10L from Brittania at the end of 90 days

That’s a quick 10% return for the investor, but obviously, it comes with certain risks as well

risk one:

Credit Risk

In our example, The invoice was from Brittania, a very well-known company, and we know they will honour their credit, but what if the invoice was from some random company we have never heard about?

In that case, There’s a chance that they might not pay 10L rs at the end of 90 days.

Disputed Invoice risk

So. Imagine if Brittania says, The wrappers from ABC Plastic Ltd are not made from good quality material, and they are having issues with it. In that case, Brittania might refuse to make the full payment.

So, Let’s look at why Invoice discounting stands out when compared o other investment opportunities.

Short-term investments

We don’t have to wait for a year or till maturity like NCDs and MLDs or Bonds. Some Invoice discounting tends to pay out in a very short period, like 60-90 days.

Portfolio Diversification

We can use Invoice discounting to diversify our portfolio further since it’s not linked to the stock market and doesn't matter if Brittania shares are going up or down. You’ll still get your money at the end of the credit period if the company doesn't default.

That's all from our side. Do let us know if you know where one can invest in an invoice discounting product and what is the minimum investment for a retail investor.