Invoice discounting: What it is and where to start

Small businesses often struggle with cash flow while waiting for clients to pay invoices. Delayed payments can disrupt operations, making it harder to cover expenses or invest in growth.

Invoice discounting offers a practical solution, providing access to cash tied up in receivables—often within days instead of waiting weeks or months.

But we know that it’s not the only option that offers businesses the liquidity they need. Let’s explore how invoice discounting works, its differences against invoice factoring, and other alternative financing options to help your business make the right choice.

What is invoice discounting?

In simple terms, invoice discounting allows businesses to unlock cash from unpaid invoices by using them as collateral for short-term financing. In return, the business receives a percentage of the invoice value from a third-party financier. Once the customer pays the invoice, the business repays the financier, including any agreed-upon fees.

Businesses that can’t wait for delayed payments—or have limited access to traditional financing—can benefit significantly from this approach. Some more benefits of invoice discounting include:

• Short-term financing solution: Invoice discounting is designed to be a short-term loan, providing quick cash without locking businesses into long-term agreements.
• No need for additional collateral: Unpaid invoices themselves act as collateral, eliminating the need to put up other business assets as security.
• Improved cash flow: Accessing cash from invoices early ensures businesses can cover operational costs, pay suppliers, or invest in growth opportunities without waiting for customer payments.

Common use cases of invoice discounting

Invoice discounting is commonly used when businesses need immediate cash to cover operational costs or seize new opportunities while waiting for customer payments. Here are some scenarios where invoice discounting proves useful:

• Seasonal businesses: Companies that experience fluctuating cash flow due to seasonal demand can use invoice discounting to maintain operations during slow periods.
• Growth-focused companies: Businesses aiming to scale quickly may rely on invoice discounting to fund inventory purchases or new hires before receiving customer payments.

How does the invoice discounting process work?

With invoice discounting, your loan amount only goes up to the value of your outstanding invoices (or accounts receivable). This means you cannot borrow beyond the number of sales you make at any given time. As such, it is not a good option for businesses that need investment before attracting clients.

While the process may vary depending on the lender or finance company, the general steps typically include the following:

1. Apply for invoice discounting: Submit financial details like your revenue and business credit score. Some lenders may assess your customers’ credit instead.
2. Receive terms from the lender: Check the percentage of the invoice you’ll receive, payout timelines, repayment terms, and fees.
3. Submit unpaid invoices: Choose which invoices to submit for funding—most agreements let you decide on a case-by-case basis.
4. Receive an advance: The time frame depends on the lender and the loan amount, but typically runs 1-2 business days. It should always be in less time than the customer is expected to pay the invoice.
5. Repay the lender: Once your customer pays, repay the lender the business loan amount plus service fees.

Invoice discounting vs. invoice factoring

Invoice discounting and invoice factoring both provide businesses with fast access to cash tied up in unpaid or open invoices, but they operate differently. While invoice discounting involves borrowing against the value of invoices, invoice factoring involves selling the invoices outright.

Here’s how the two compare:

Both options can provide fast, flexible financing, but understanding the differences in choosing the right invoice financing method ensures you select the right one for your business’s needs.

When is invoice discounting a good idea?

Invoice discounting is a good choice when your business needs quick cash flow while maintaining control over customer relationships and payment collections. However, it may not be the best option for businesses that struggle with chasing overdue payments or lack sufficient resources to manage collections.

Choosing invoice discounting makes sense for businesses that:

• Have reliable customers who pay on time, reducing the risk of late payments
• Want to retain direct communication with customers to preserve strong relationships
• Need short-term financing without committing to long-term agreements

On the other hand, invoice factoring might be a better choice if your business:

• Prefers to offload the burden of chasing and managing late invoice payments
• Wants to streamline operations by outsourcing collections to a factoring company
• Faces high volumes of overdue accounts that are difficult to manage internally

Understanding your business's specific needs and resources can help you decide which financing option aligns better with your goals. Whether you choose invoice discounting or factoring, having the right solution in place ensures smoother cash flow and stronger operations.

Pros and cons of invoice discounting

Like all forms of debt, invoice discounting has pros and cons. Deciding whether to pursue this type of financing depends on the nature of your business, its financial situation, and your personal preference as a business owner.

Here are some main advantages of disadvantages to consider:

Optimize your finances with Ramp

Invoice discounting is a useful tool to smooth out cash flow, but it’s not your only option. Ramp offers multiple ways to access working capital, optimize expenses, and build business credit.

Why Ramp makes financial management easy:

• Access working capital with ease: Ramp’s commerce sales-based underwriting evaluates your revenue, not your years in operation, offering higher credit limits without the hassle of traditional documentation.
• Optimize expenses effortlessly: Automate invoice processing, control spending by category, and gain real-time insights into your finances with Ramp’s expense management tools.
• Build credit while saving money: Use Ramp to stay on top of payments and save on purchases made with your Ramp card, all while improving your business credit.

Try Ramp to simplify your finances, automate accounts payable and accounting, and optimize credit building.