Early payment discounts have been around for decades—but a newer twist on the concept has made them an attractive alternative to traditional funding sources.
In the past, the only option for offering a discount for early payment was to add alternate credit terms to your invoices—usually with a statement like 2/10, Net 30.
In simple language, 2/10, Net 30 translates to:
“Pay me in under 10 days, and I’ll give you a 2% discount; otherwise, the full balance is due within 30 days.”
With the recent introduction of online early payment programs, also known as dynamic discounting, you can now view your invoices online and request early payment on demand.
This new form of early payment discounting puts you in control, guarantees you actually get paid if you take a discount and ties cost to the number of days you’re paid early.
Let’s take a look at how dynamic discounting compares to using more traditional sources of funding to improve cash flow.
Dynamic discounting vs. factoring
When you factor an invoice, you’re selling it to a third party at a discount in exchange for the immediate payment of 70% to 90% of the invoice amount.
After your customer pays the invoice, the factor pays you the remaining balance of your invoice minus its fees.
Factors charge a flat-rate invoice fee, generally 1% to 4%, and then charge interest on top of that based on the amount of time between when the factor buys the invoice and when your customer pays the invoice.
These fees add up. It’s not uncommon to see APRs above 30%—making factoring your invoices one of the most expensive ways to improve cash flow.
Factors usually advance a portion of outstanding invoices, or the advance rate, and pay you the remainder only after they get paid the full amount.
In contrast, there is no advance rate with Dynamic Discounting. Rather than wait for the additional amount due, you can have your customer pay that invoice early, which will release your remaining funds and give you an immediate boost in cash flow.
How factoring compares to dynamic discounting
Both factoring and dynamic discounting provide access to capital by discounting your invoices.
However, with dynamic discounting you:
- Receive the full amount of your invoice up front, minus the discount
- Maintain full ownership of your invoices
- Pay substantially less in fees
|Access to funds||2–7 days||24–48 hours|
|Cost in APR||12–48%+ APR1||3%–18% APR|
|Credit limits||70–90% of AR||100% of available AR|
|1. Based on total effective APR rate that includes invoice fees and rolling interest charges. *Comparison based on the C2FO dynamic discounting platform. May vary for other dynamic discounting platforms.|
With dynamic discounting, you receive more of your money, maintain complete ownership, and pay far less.
With Dynamic Discounting, the cost is based on open invoices with your customers, while factoring price is determined by the credit profile of the customer (debtor’s) portfolio. The factor is more concerned with the creditworthiness of the invoiced party than with that of the company from which it purchased the receivable.
Because banks require complex underwriting on every supplier who uses their program, only the largest Tier 1 suppliers — generally 20% or less of a supplier base — have access to this form of early payment.
In addition, the type of factoring you choose can have a significant impact on your balance sheet and your cash flow. Factoring providers generally offer two different solutions: non-recourse factoring and recourse factoring.
With recourse factoring, business owners take on the risk if their customer fails to pay the invoice on time. Few factors offer solutions that are truly non-recourse, which removes the receivable from your balance sheet and cash is added as an asset.
But there is one area that factoring has a slight edge: Some of your customers may not offer an early payment program, which means that some of your invoices may not be available to convert immediately into cash flow.
With factoring, however, you can advance funds on any factor-approved invoice, regardless of customer. Should you find yourself in this situation, there is also another easy alternative that is less expensive called C2FO Receivables Finance.
Dynamic discounting vs. supply chain finance
Supply chain finance (SCF), also known as reverse factoring, is a way for very large enterprise customers to provide liquidity to your business.
It’s called reverse factoring because your customer initiates the program with the bank, generally so that your customer can extend its payment terms.
Fees are based on the creditworthiness of your large customer instead of your company’s creditworthiness.
The result is a more favorable financial rate since your largest customers likely have a better credit rating than your business.
Another benefit of supply chain finance over traditional factoring is that 100% of your customer-approved invoice value (minus fees) is available instead of just 70% to 90%.
The rest of the mechanics remain the same. Ownership and payment remittance are still shifting to a third party.
How supply chain finance compares to dynamic discounting
The primary benefit of supply chain finance is a very low cost.
Unfortunately, these programs are often only available to select, tier-one vendors and are generally burdensome to set up with the bank.
|Supply Chain Finance||Dynamic Discounting|
|Access to funds||24–48 hours||24–48 hours|
|Cost in APR||3.12–7.92% APR1||3–18% APR|
|Credit limits||100% of available AR||100% of available AR|
|1. Based on LIBOR rate as of 11/27/2018 + 20 to 500 basis points based on your customer’s creditworthiness. Comparison based on the C2FO dynamic discounting platform May vary for other dynamic discounting platforms.|
If your business has access to a supply chain finance program, the cost will usually be less than dynamic discounting, but will vary from program to program.
The main benefits of using dynamic discounting over supply chain finance are a fast and easy approval process for early payment requests and you maintain full ownership of your receivables.
Dynamic discounting vs. lines of credit
A line of credit (LOC) is a financing facility that you can draw on demand—and it works much like a credit card.
Lines of credit have a limit set by your bank during the approval process and drawing on the funds reduces that limit, or the amount of available credit.
When you repay the line, your available credit increases, up to a maximum of your credit limit.
Lines of credit can provide a great deal of flexibility at a low cost—but they’re hard to get and almost always require personal guarantees.
They also commonly include invasive covenants, or rules, that you must comply with in order to keep the line open. Reporting covenants often require you to communicate things like:
- Unforeseen events within the business that could impact long-term earnings
- Changes in financial ratios related to cash flow and leverage
- The loss of key personnel
To secure a line of credit, your company must have a long business history and enough existing cash flow and assets to repay the line almost immediately.
The cost for a line of credit is most often based on the Wall Street Journal prime rate plus 0 to 3%—the additional interest amount will depend on the strength of your credit.
How a line of credit compares to dynamic discounting
Like a line of credit, you can use dynamic discounting to access cash on demand.
The difference is that the amount of funds you have access to through dynamic discounting is determined by the value of your approved invoices rather than a pre-set limit by your bank.
Unlike a line of credit, dynamic discounting is quick and easy to set up and there are no covenants, maintenance fees, or balances to pay back.
|Line of Credit||Early payment discounts|
|Setup time||Months to years||Hours|
|Access to funds||Within 24–48 hours of approval||24–48 hours|
|Cost in APR||5.25%–8.25% APR1||3%–18% APR|
|Credit limits||Based on creditworthiness and sometimes collateral||100% of available AR|
|Based on WSJ Prime Rate as of 11/27/2018 + 0 to 300 basis points. *Comparison based on the C2FO dynamic discounting platform May vary for other dynamic discounting platforms.|
At the prime rate, a line of credit might be cheaper than dynamic discounting but this quickly changes if any additional interest is added.
The simplicity of dynamic discounting is also an important thing to consider as the hassle of complying with covenants may not be worth a slight cost saving.
Even if dynamic discounting is a more expensive way to bring in cash than your line of credit—you can still use an early payment program in conjunction with a line of credit to increase available capital.
Dynamic discounting vs. asset-based loans
Asset-based working capital loans (ABLs) are secured against receivables, and sometimes inventory.
They often require a personal guarantee and can come with extensive covenants, many of which are even more oppressive than those that come with a line of credit.
With an ABL, your bank may require monthly, weekly, or even daily reporting to ensure loan amounts do not exceed the value of collateral.
ABLs can be easier to get than a line of credit because an ABL is secured by specific collateral—whereas most lines of credit are secured by general business assets.
Finally, setting up an ABL is not trivial as it requires complete access to all of your accounts receivable and inventory to fully document the collateral that capital is being made available against.
How an asset-based loan compares to dynamic discounting
Unfortunately, while it is less expensive, using your ABL isn’t nearly as quick and easy as dynamic discounting or online factoring platforms.
You also have to collateralize your entire business to have access to an asset-based loan. This is not a simple process.
With some banks, accessing capital from your ABL will require you to undergo a lengthy approval process before the funds are added to your account.
|Bank ABL||Dynamic Discounting|
|Setup time||Months and > $7m limit||Hours|
|Access to funds||Within 24 hours of approval||24–48 hours|
|Cost in APR||3.12%–13.12% APR1||3%–18% APR|
|Credit limits||Based on collateral||100% of available AR|
|1. Based on LIBOR rate as of 11/27/2018 + 100 to 1000 basis points.*Comparison based on the C2FO dynamic discounting platform. May vary for other dynamic discounting platforms.|
If you’re able to secure an ABL, it should be your least expensive source of funding outside of supply chain finance and some dynamic discounting scenarios.
However, it is important to note that most banks will only advance 80% of available collateral balances on asset-based loan facilities.
When it comes to funding your business, the options we’ve presented above aren’t either / or—you can use a combination of these sources based on timing, cost, availability, and impact on accounting.
For example, many companies use dynamic discounting to decrease the fees charged by their factor by shortening the amount of time an invoice is outstanding.
Others use dynamic discounting alongside their line of credit to increase the amount of available capital.
Several large companies use dynamic discounting in conjunction with factoring and an ABL to pull forward cash at quarter- and year-end from future-due invoices to their current balance sheets.
If you have to choose one or the other, here are a few rules of thumb
Factoring vs. dynamic discounting
Use factoring when not all of your invoices are available through a dynamic discounting or supply chain finance program and you do not have access to less expensive funding sources.
Or better yet, use C2FO’s Receivables Finance platform to finance your invoices that aren’t on the dynamic discounting platform.
Supply chain finance vs. dynamic discounting
Use supply chain finance when you do not have access to a dynamic discounting program or when your supply chain finance program is less expensive to use.
Asset-based lending vs. dynamic discounting
Use a dynamic discounting program instead of your ABL when you don’t have time to wait for approvals or recertifications or to increase the amount of capital available to your organization.
Line of credit vs. dynamic discounting
Use a dynamic discounting program instead of your line of credit whenever dynamic discounting is less expensive or when you need additional capital beyond your credit limit.
|Factoring||LOC||Bank ABL||SCF||Dynamic Discounting|
|Setup time||Weeks||Months to years||Months and > $7m balance||Days||Hours|
|Access to funds||2–7 days||Within 24 hours of approval||Within 24 hours of approval||24–48 hours||24–48 hours|
|Cost in APR|
|5.25–8.25% APR1||3.12–13.12% APR2||3.12–7.92% APR3|
|Credit limits||70–90% of AR||Based on creditworthiness and sometimes collateral||Based on collateral||100% of available AR||100% of available AR|
Comparison based on the C2FO dynamic discounting platform. May vary for other dynamic discounting platforms.
Please note: To make things easier to compare we represented costs in terms of APR over a 30 day period.
The way that cost is communicated and calculated across financial instruments can vary. Standard representations can be found below.
|Factoring||LOC||Bank ABL||SCF||Dynamic Discounting|
|Cost||Invoice Fees + Rolling Interest|
WSJ Prime or Libor +
0 to 300+
100 to 1000 basis points
20 to 500 basis points
|3 to 18% APR|