How Does Invoice Discounting Work in KSA?

Invoice discounting is particularly valuable in markets like the Kingdom of Saudi Arabia (KSA), where businesses frequently face lengthy payment terms of 30, 90, 120, 180 days or even more. Instead of allowing these invoices to remain inactive on the balance sheet, companies can use them to meet their immediate working capital needs through invoice discounting.

Let's explore what invoice discounting is , how it works, key differences between invoice discounting, financing, and factoring and more.

What is Invoice Discounting?

Invoice discounting is a financial solution that allows businesses to borrow against the value of their unpaid invoices. When a company issues invoices to its customers with extended payment terms, it can approach an invoice discounting provider to secure a short-term loan based on the value of these invoices. The provider advances a percentage of the invoice total, typically between 70%-90% depending upon the term and when the customer settles the invoice, the business repays the loan along with a small fee (in addition to interest). 

Unlike invoice factoring, bill discounting is often confidential, meaning the business retains control over its sales ledger and remains responsible for collecting payments from customers.

How Invoice Discounting Works in KSA

One key difference between invoice discounting in other countries and Saudi Arabia is its adherence to Islamic finance principles. In Saudi Arabia, bill discounting agreements must comply with Shari'ah law. This means avoiding interest and ensuring that all transactions are fair and transparent.

Here’s an overview of the general process for discounting invoices in Saudi Arabia:

1. Issuance of Invoice: A business (the supplier) sells goods or services to its customer (the buyer) and issues an invoice with a payment term, which could range from 30 to 180 days.
2. Application for Invoice Discounting: To meet immediate cash needs, the supplier approaches an bill discounting provider (a financial institution or specialized lender) and submits the unpaid invoice as collateral.
3. Evaluation by the Provider: The provider assesses the invoice and the creditworthiness of the buyer. If satisfied, they agree to advance a percentage of the invoice value, typically between 70% and 90%, to the supplier. The remaining amount (minus fees) is paid once the invoice is settled.
4. Advance Payment: The provider disburses the agreed-upon amount to the supplier, usually within a few days, offering immediate liquidity to cover operational expenses or fund growth initiatives.
5. Repayment Process: When the buyer eventually pays the invoice (directly to the supplier or via a controlled account), the supplier repays the lender the advanced amount plus a pre-agreed fee, usually ranging from 1% to 5% of the invoice value.

Example of a Typical Invoice Discounting Scenario

Consider a Saudi-based manufacturing company, XYZ Manufacturing, which sells goods worth SAR 100,000 to a retailer, ABC Retail, with payment terms of 120 days. XYZ Manufacturing needs immediate cash flow to purchase raw materials and pay wages, so it approaches an invoice discounting provider.

The provider evaluates the invoice and decides to advance 90% of its value (SAR 90,000) to XYZ Manufacturing, charging a 2% fee (SAR 1,800). After 120 days, ABC Retail pays the full invoice amount of SAR 100,000. XYZ Manufacturing then repays the lender the SAR 90,000 advanced, plus the 2% fee, completing the transaction without affecting its long-term financial stability.

This process helps businesses in KSA maintain a steady cash flow, supporting their operations and growth while waiting for their customers to settle outstanding invoices.

How Invoice Discounting Differs from Other Financing Methods

Here’s how invoice discounting differs from other financing methods such as loans, overdrafts, and short-term credit:

1. Confidentiality: Discounting Invoice is often confidential, meaning customers are unaware of the arrangement, unlike loans or overdrafts that may require disclosure.
2. Control and Responsibility: Businesses retain control over their invoices and remain responsible for collecting payments, unlike some other methods where the lender handles collections.
3. Quick Access to Funds: Bills discounting offers faster access to cash, often within a few days and with less paperwork, compared to traditional loans or credit lines.
4. Customer Creditworthiness: Approval is based on the creditworthiness of the business's customers, not the business itself, making it accessible for companies with weaker credit histories.
5. Cost Efficiency: Fees for invoice discounting are generally lower than the interest rates on loans or overdrafts, offering a more cost-effective solution for short-term financing.
6. Recurring, Shorter Cycles: It provides flexible, recurring financing aligned with invoice payment cycles, unlike long-term loans that require extended commitments.

Invoice Discounting vs Invoice Financing vs Invoice Factoring

Invoice Financing is a general term that covers both invoice discounting and invoice factoring. It involves obtaining funds by using outstanding invoices as collateral.

Invoice Discounting vs. Invoice Factoring:

• Invoice Discounting: The key difference is that with invoice discounting, the business retains control over its unpaid invoices and is responsible for collecting payments from customers. This method is more confidential, as customers typically don’t know that the business is using invoice discounting.
• Invoice Factoring: In contrast, with invoice factoring, the business sells its invoices to a factoring company. The factor then takes over the responsibility for collecting payments and managing the invoices. This method is less confidential, as customers are aware that their invoices are being factored. Factoring can also include non-recourse options, where the factor assumes the risk of non-payment.

Key Considerations While Discounting Invoice

Here are the key considerations for discounting bills in Saudi Arabia, streamlined into five main points:

• Regulatory and Shariah Compliance: Ensure the invoice discounting process adheres to Saudi Arabian financial regulations and Islamic finance principles, avoiding interest (Riba) and ensuring fairness.
• Provider Selection and Costs: Choose a reputable provider with competitive fees and favourable terms. Compare different providers to find the best fit for your business needs.
• Customer Relationships and Confidentiality: Decide if confidentiality is important and select a provider that offers confidential bill discounting. Assess the creditworthiness of your customers as it will impact financing terms.
• Operational Efficiency: Ensure the provider’s process involves minimal paperwork and is quick and easy. A cumbersome process can defeat the purpose of seeking prompt funding.

Conclusion

Invoice discounting offers a way for businesses to quickly access cash tied up in unpaid invoices, improving liquidity and cash flow. In Saudi Arabia (KSA), invoice discounting must adhere to Islamic finance principles, making it distinct from conventional methods. Understanding these principles and researching the costs on all the platforms associated with invoice discounting is crucial before discounting your unpaid invoice.