Invoice discounting: Short investment tenure with high fixed returns; Should you invest?

We are always told to invest for the long term to earn high returns. While that is correct, some investment products are an exception to this. Invoice discounting is one of them. With this investment product, you can earn high returns for short investment tenures. So, let us understand what invoice discounting is and whether you should invest in it.

What is invoice discounting and how does it work?

The invoice discounting process involves selling an unpaid invoice by the company that has raised it to a bank, NBFC, or investors (on an invoice discounting platform) at a partial value.

The concept of invoice discounting works towards resolving the working capital of start-ups, micro, small and medium enterprises (MSMEs). When these companies sell goods to large companies (blue chips) and raise invoices, they have to wait till the credit period gets over to get paid. The credit period may range from 30 to 120 days. If start-ups and MSMEs wait that long to get paid, their business may suffer as they have to constantly invest the money back into the business to grow it.

Earlier, they approached banks and NBFCs and asked them to give cash against the invoices at a discounted rate. For example, if the invoice amount is Rs. 1 crore, the bank may discount it for Rs. 95 lakhs, depending on the risk assessment.

In this way, through the invoice discounting process, the start-ups and MSMEs get access to cash immediately, which they can reinvest in the business to maintain the growth momentum. Once the invoice becomes due for payment, the bank that discounted the invoice will get Rs. 1 crore (invoice face value).

The bank's profit will be the invoice face value minus the invoice discounted value. In our example, the bank's profit will be Rs. 5 lakhs (Invoice face value Rs. 1 crore – Invoice discounted value Rs. 95 lakhs).

In the last few years, some fintechs have brought the concept of invoice discounting within reach of retail investors.

Which platforms allow investors to invest, and what problem are they solving?

Platforms such as Jiraaf, KredX, Tyke, TradeCred, Leaf Round, etc., provide invoice discounting as an investment product to their members (retail investors). These fintechs act as intermediaries between companies (wanting to discount their invoices) and retail investors (who want to fund them and earn a profit). Some of the things that investors should note include:

1. The investment tenure usually ranges from 30 to 120 days.
2. The returns usually range from 11 to 18% IRR.
3. Different platforms have different minimum investment requirements, which may range from Rs. 10,000 to Rs. 1,00,000.

With invoice discounting, the fintechs are working on two things:

1. They are unlocking the value of unpaid invoices for companies that have raised them, thus providing them cash flows.
2. They are providing short-term and high-return investment opportunities to retail investors wanting to participate in invoice discounting deals.

How does an invoice discounting cycle work?

Let us understand the invoice discounting cycle with the help of an example. Lets Transport is a provider of intra-city truck aggregator services. It has raised an invoice of Rs. 1.95 crores on Bajaj Electricals for the supply of services. The invoice has a credit period of 91 days.

Lets Transport doesn’t want to wait for 91 days to get paid. So, it approaches the Jiraaf platform for invoice discounting. The Jiraaf team evaluates the invoice and does the overall assessment of Lets Transport and the company on whom the invoice has been raised. Once all the checks are cleared, Jiraaf makes the invoice discounting transaction live on their platform. The return on investment promised is 12.10% IRR.

The investors can check the details, and if satisfied, they can go ahead and invest. On the Jiraaf platform, the minimum investment for invoice discounting deals is Rs. 95,000 and in multiples. In this way, Lets Transport can raise the money against the unpaid invoice. The amount raised will be invoice face value (Rs. 1.95 crores in this case) minus the discount rate.

After 91 days, the invoice will become due. Bajaj Electricals will pay the entire invoice amount of Rs. 1.95 crores, and the investors will get back their investment amount and profit.

Due to the shorter tenure of the investment, the repayment with returns is always in the form of a single bullet payment at the end of the investment tenure. There are no monthly or quarterly repayments.

How are the returns taxed?

We have seen how investors can earn returns in the range of 11 to 18% IRR on various invoice discounting deals on various platforms. The returns are added to an individual's overall income and taxed at the slab rate.

What are the risks involved?

The biggest risk in an invoice discounting transaction is the delay or default in invoice payment by the company on which the invoice has been raised. So, in an invoice discounting deal, it is important to evaluate the credibility of not just the company that has raised the invoice but also the company on whom the invoice has been raised. 

Ultimately, it is the company on whom the invoice has been raised that will make the payment. The other risk is the company (on whom the invoice has been raised) raising objections on the quality of the goods that have been supplied and disputing the invoice amount.

Some fintech platforms try to cover the risk of delay or default in invoice payment by taking security from the company that has raised the invoice. The security may be in the form of a cheque or a personal guarantee from the promoters. However, that may still not mitigate the risk entirely.

Should you invest in invoice discounting?

Invoice discounting is a high-risk, high-return investment opportunity. It is suited for investors with an aggressive risk profile. So, if you have that kind of risk appetite, you may invest some portion of your overall investment portfolio in invoice discounting. However, be mindful of the risks before taking the plunge.

Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.