Investors these days are being more patient and staying put in the equity markets for the long-term, expecting better returns. However, some investors are yet not comfortable with the equity markets because of their volatility. They are interested in profit maximization beyond the stock market, in a short-term period. Bank Fixed Deposits (FD) or Life Insurance plans do not attract them because of their lengthy timeline and inflation dilemma. The below discussion is for those investors. The investment option is called invoice discounting - which is related to both MSMEs and big companies, in two different segments.
How is invoice discounting being operated?
Be it a big company or a medium scale company, when they are operating in a market they are most likely to sell products/goods to the buyers. Now, when a product is sold in the market, this includes multiple ingredients and items within it. For example, if Apple is selling mobile phones in the market, they will certainly need parts or materials like packaging items, metal parts, glass, etc. These will be manufactured by other suppliers to send to Apple, and they will assemble the parts, enable the software, do the packaging, and sell the final product. Here comes the importance of the suppliers or manufacturers.
When Apple will order its supplier to make mobile parts for them, they will not give the total payment for those parts. Rather, they will offer the suppliers an invoice that will commit the full payment for the manufactured parts, which will be paid after around 30-90 days. With this commitment, the manufacture will supply the parts to Apple. But what happens if the supplier needs the money immediately, cannot wait any longer? Then the supplier can sell the invoice to other investors in the market by online financial platforms. The investor will have to pay the amount payable by Apple to the supplier, but they will get a discount of 20%. Later the production company will pay the full amount directly to the investor, whereby the investor will have a profit margin.
This is why the investment option is called invoice discounting. For example, if the total amount payable by Apple is Rs. 1000, the investor will pay only Rs. 800 to the supplier. The 20% loss is neglected because it is assumed that the supplier has already counted profits within this amount. Thus, the supplier can fulfill its demand of immediate money, with a lesser profit. Later, after 30-90 days, at the time of payment, when Apple will remunerate for the parts, they will directly pay the full Rs. 1000 to the investor. So, in that way, within a very short period of 30-90 days, the investor will earn a good profit.
However, the total profit of 20% is not attributed to the investor alone. A margin of this, at around 8%, is taken by the online financial platform, where the invoice was sold by the supplier. Hence, the rest 12% will be given to the investor. Now, this 8% and 12% can vary depending on the companies involved and the platforms.
In India mostly the MSME sector runs its operations through an invoice discounting system to earn their working capital. They manufacture for large-scale companies and earn the amount immediately from investors. Investors then after the short-term period earn their 12% profit.
The invoice discounting is a great investment opportunity, keeping in mind certain risk factors. The investor should always analyze the brand value of the company who will give the final payment. The credit history or credit risk should be checked, to understand how and when they have done their earlier payments. Along with this, the company's insolvency factor or debt obligation should be another concern to look at.
On the other hand, the manufacturer company, who is dealing the invoice, should also be checked to understand if they are good companies or not. Otherwise, they might deal with invoices that are not going to be settled in the future. Also, the disputed invoice is another risk; if the sold products are disputed, then the big company can reject to pay the money, or can pay only a percentage of the total amount payable. In that case, the investor will face loss.
Invoice Discounting platforms
KredX, Receivables Exchange of India Ltd (RXIL), TradeCred, Finovate Capital, Invoice Mart, M1 Treds, and Priority Vendor are some of the popular online debt platforms, where the invoice discounting ecosystem is operated. In these platforms, the investors should find the risk mitigations, financial reports, credit history, shareholders details, internal rate of return (IRR), etc. to have a better outlook on the deal.
However, this investment option is most likely for big investors who can put a lump sum amount in this, a very small-scale investment will not be appropriate for the field. Also, not all of the companies - manufacturers or sellers will be reputed companies here. So, an in-depth study of the companies is required for invoice discounting.