Invoice Discounting - say what? (Part 1/2)

When I was studying for my bachelor's degree (a very staid B.Com), there was a subject called "Banking". It was one that I do not have any specific memories of, other than two phrases which stayed with me till date: "Bill Discounting" and "Factoring". Nearly 20 years after graduating, I stumbled upon invoice discounting as an investment where I could participate.

In this blog - which is part 1 of 2, I will just talk about the concept. In the subsequent blog, I will talk about how the process of investing works along with my experience on a couple of these platforms.

Backup a bit: What the heck is invoice discounting?

If you already know what it is, skip this section. I decided to write this paragraph after I was asked at the end of a long discussion on my invoice discounting experience this very question !!!

Here is a brief 1 minute video I made explaining the concept

So in a nutshell, Invoice discounting is a financing method where businesses sell their unpaid invoices to investors at a discounted rate, effectively turning their accounts receivable into cash. This process helps businesses improve their cash flow by receiving funds upfront, while investors earn returns through the difference between the discounted purchase price and the full invoice value.

Okay, sounds like what a bank should be doing. Why are we talking about it?

Banks, financial services firms and even specialist agencies have always provided this as a service to those who want to manage their cashflow or reduce their risk of collection default. But someone smart decided to make a business out of bringing together people who had money to invest, and the firms/people who had invoices to discount. Today, several players are there in this market, and they claim to provide anywhere between 11-20% returns (per annum).

How does this work?

In India, several platforms facilitate invoice discounting= transactions. Here's a step-by-step breakdown of the process that most follow:

1. A business uploads its unpaid invoices on the invoice discounting platform.

2. The platform verifies the invoices and assesses the creditworthiness of the debtor.

3. Investors browse the available invoices and choose the ones they want to invest in.

4. The platform discounts the invoices, and the investors pay the business the discounted amount.

5. There is a minimum specified investment per investor - so one invoice may be "bought" by many people. For e.g. an invoice of INR 9.5 Lacs may be listed for purchase of INR 9 Lacs (INR 50k is the discount), and this may be bought by 3 people who each put in 3 lacs. (More in the next blog)

6. Once the debtor pays the full invoice amount, the platform releases the funds to the investor, minus any fees.

7. The platform makes its fees as a percentage of the discount, or as a flat fee

What kind of investment is this!!??

This is what one calls "Alternative investments" which have gained popularity in recent years as investors search for ways to diversify their portfolios beyond traditional assets like stocks and bonds. The profit made from such arrangements are considered income from other sources, and taxed at individual slab rates.

Coming up in Part 2!!!

Popular platforms in India, returns made, risk involved and the experience of using invoice discounting platforms!