What it means
The idea is simple: you are owed money in 60 or 90 days but you need cash today, so you sell or pledge that claim at a discount. The financier advances most of the invoice value immediately and collects the full amount when the customer pays.
Two structures dominate. In a with-recourse arrangement the business remains liable if the customer never pays, so the receivable often stays on the balance sheet with a matching borrowing; in a without-recourse arrangement the credit risk passes to the financier and the receivable is usually removed.
This matters because it is one of the fastest ways to convert sales into working capital without raising equity or arranging a term loan. Growing businesses frequently discount receivables to bridge the gap between paying suppliers and being paid by customers.
The cost is charged as a discount rather than as headline interest, which makes it easy to underestimate. A fee that looks small on a 90 day invoice can be an expensive annual rate once you convert it, so the sensible comparison is always the annualised cost against an overdraft or bank facility.
Disclosure deserves attention too. With-recourse discounting creates a contingent liability, because if the customer defaults the business must repay the advance, and that exposure is normally described in the notes to the accounts.
There is also a commercial signal to manage. Customers may be told to pay the financier directly, so the arrangement becomes visible to them, and some businesses prefer confidential facilities for that reason even though they cost more.
In practice
Real-world examples.
Example
A staffing agency pays contractors weekly but bills clients on 60 day terms. It discounts its largest client invoices each Friday, accepting a fee of about 2% per invoice so that payroll is always funded on time.
Example
An exporter discounts a $500,000 receivable without recourse because the overseas buyer is unfamiliar. The bank takes the credit risk, the exporter removes the receivable from its balance sheet, and the higher fee is treated as the price of certainty.
Example
A construction subcontractor discounts invoices with recourse to fund a new site. When one main contractor fails, the subcontractor has to repay the advance itself, and the contingent liability disclosed in its accounts becomes a real one.
Formula
Calculation
The core relationships are: Discount = Face value x discount rate x (days / 360), and Cash proceeds = Face value - discount - any service fee.
A packaging supplier discounts a $200,000 invoice due in 90 days. The bank charges a discount rate of 8% a year plus a 1% service fee on face value.
Discount = $200,000 x 8% x 90/360 = $4,000. Service fee = $200,000 x 1% = $2,000. Cash proceeds = $200,000 - $4,000 - $2,000 = $194,000.
Total cost is $6,000 on $194,000 received, which is 3.09% for 90 days. Because 90 days is a quarter of a year, the simple annualised cost is roughly 3.09% x 4 = 12.4%, well above the headline 8% the supplier first focused on.Case study
Seen in the real world.
Meridian Fixings is a fictional distributor used purely as an illustrative example. It won a national retail contract that tripled its order book but came with 90 day payment terms, while its own suppliers demanded payment in 30 days.
Rather than turn the contract down, Meridian discounted the retail invoices with its bank, receiving about 97% of face value in cash within two days of invoicing. The arrangement cost roughly $220,000 across the first year on $7,000,000 of discounted invoices, which the finance director compared against a gross margin of well over $1,000,000 on the same sales.
The lesson in this illustrative story is that discounting was worth it while the margin comfortably exceeded the cost, but the board set a rule to review that comparison every quarter. If margins had thinned, the same facility would quietly have turned a profitable contract into a break-even one.
Watch out
Common mistakes.
- Comparing the discount rate with a loan interest rate directly, when the discount applies to a short period and must be annualised before the two are comparable.
- Assuming discounting removes the receivable from the balance sheet, when a with-recourse facility usually leaves both the asset and a matching borrowing in place.
- Treating discounting as free because there is no monthly repayment, when the cost is simply buried in the gap between face value and cash received.
Questions
People also ask.
Is discounting the same as factoring?
They overlap, but factoring normally includes the financier running collections, while discounting often leaves the business to collect and simply advances cash against the invoices.
Does it affect reported revenue?
No, revenue is recognised when the sale is made; discounting only changes the timing of cash and adds a financing cost below the gross margin line.
Will customers know?
In a disclosed facility they are told to pay the financier, whereas a confidential facility keeps the arrangement invisible to them at a higher fee.
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