- 14 Feb
Using Early Payment Discounts To Improve Cash Flow
Recently, we received an enquiry from a prospective customer seeking selective invoice finance. They were having a temporary cash flow problem, but they had two invoices totalling £5K that they said they wanted to discount in order to access the cash tied up in those invoices, immediately.
Selective Invoice Finance Versus Early Payment Discounts
Selective invoice finance would seem to be the perfect solution, as there would be no obligation for them to discount further invoices, and it would release circa 85% of the invoice values immediately. Furthermore, these types of facilities can be set up very quickly, so they are likely to be able to receive funds within a day or two at most.
However, in this particular situation the debtors were in a cash rich position, whereby they were able to make payment prior to the due date of the invoices. The only issue was incentivising them to make an early payment. By offering a small discount on the value of the invoices, the prospect was able to get them paid immediately, by the customers.
The key consideration in such situations will be the amount of discount that has to be given in order to achieve early payment by your customers. If you customers demand more than just a few percentage points off the value of an invoice, in order to pay immediately, it may well turn out that invoice discounting is a more cost-effective option.
Furthermore, all customers may not be in a cash rich position such that they can afford to make an early payment, in return for an early settlement discount. In such cases, an invoice financing arrangement, possibly on a selective basis, could be a better solution. The other advantage of using an invoice financing arrangement is the ability to discount further invoices, as and when cash flow issues present themselves, without having to go cap in hand to customers each time.
The size of the early payment discount required can often be an issue. People tend to think in terms of round amounts e.g. 5%, 10% etc. which can make offering discounts a very expensive option when compared with the cost of invoice discounting the invoice.
Another drawback of offering discounts, rather than using invoice discounting, is that some customers will take these discounts even though they pay late. OK, technically you may have the right to pursue them for the balance, but in practice this can often prove to be cost prohibitive, due to the small amounts of discount that maybe involved. In some cases, customers can just end up taking the early settlement percentage, or amount, off of their payments, regardless of when they pay, and you may be forced to write this off.