Invoice discounting is a way for a supplier to be paid now for an invoice that its customer will pay only later. An investor or a bank pays the supplier most of the invoice amount today. Later, the customer pays the full amount, and the investor keeps the difference as its earning. It is a common way to fund working capital without a loan against property.
Here is why it is needed. Large companies often pay their suppliers 60 or 90 days after delivery. For micro and small suppliers, the Micro, Small and Medium Enterprises Development Act (MSMED Act) sets a limit of 45 days, but late payment is still common. A small supplier has to pay for materials and wages long before that. The unpaid invoice is money the supplier has earned but cannot use yet.
Consider a packaging supplier in Ahmedabad that delivers cartons worth ₹10 lakh to a large food company. The invoice is due in 90 days. The supplier's accounts receivable (AR) automation software, which tracks money customers owe, sends the invoice to a discounting platform. The food company confirms on the platform that it will pay. Several investors then offer to buy the invoice. The best offer is ₹9.7 lakh, paid to the supplier the next day. After 90 days, the food company pays ₹10 lakh to the investor. The ₹30,000 difference is the investor's earning. It works out to about 12% a year.
The investor is really lending against the large customer's promise to pay, not against the small supplier. So the price depends mostly on how reliable the customer is. The investor can check the customer's record with a commercial credit bureau.
In India, much of this happens on the trade receivables exchange, called TReDS. TReDS is a set of platforms regulated by the RBI, on which MSMEs sell the invoices of large buyers to banks and finance companies. Private platforms also connect suppliers with investors. Some platforms bundle many invoices together and sell them to larger investors through securitisation.
How is it different from a business loan? An MSME loan is repaid by the small business from its own cash. In invoice discounting, the money is repaid by the customer, when the customer pays the invoice.