Discounting agreement meaning: Understanding the basics
As a business, it is essential that you are aware of the different financial agreements and terms that you may encounter. One such agreement that is commonly used in the business world is a discounting agreement. In this article, we will dive deep into the discounting agreement meaning, its benefits, and how it works.
What is a discounting agreement?
A discounting agreement is a financial arrangement typically used by businesses to obtain immediate cash from a financial institution or a bank for their outstanding invoices or receivables. In simple terms, it is a process where a company sells its accounts receivable to a third party, usually a financial institution, at a discounted rate in exchange for immediate cash. This process of selling accounts receivables is also known as invoice discounting.
How does a discounting agreement work?
Here’s a step-by-step explanation of how a discounting agreement works:
1. A business delivers a product or service to a customer and creates an invoice for payment.
2. The business then sells the invoice to a financial institution at a discounted rate, typically between 70-90% of its total value.
3. The financial institution advances the business the discounted amount upfront, usually within 24 hours of the invoice’s submission.
4. The customer then pays the invoice amount in full to the financial institution on the due date mentioned in the invoice.
5. The financial institution releases the remaining balance to the business, after deducting their fee.
Benefits of discounting agreements
By opting for a discounting agreement, businesses can avail of numerous benefits, such as:
1. Improved cash flow: Discounting agreements help businesses improve their cash flow by providing them with immediate funds.
2. Access to working capital: Such agreements allow businesses to gain access to working capital, which they can use for further investment or expansion.
3. Reduced risk: Selling invoices to third-party financial institutions can help businesses minimize the risk of non-payment or late payment from customers.
4. Convenience: Discounting agreements are generally easy to set up and are more convenient than traditional loans, as they don’t require any collateral or credit checks.
Conclusion
A discounting agreement is a financial arrangement that can help businesses access immediate cash by selling their accounts receivables to a third-party financial institution at a discounted rate. It offers various benefits, including improved cash flow, access to working capital, reduced risk, and convenience. Therefore, it is essential for businesses to fully understand the discounting agreement meaning and how it works.
