Invoice Factoring Vs Discounting

By Ram - Dec 27 2023

Invoice factoring and discounting are short-term finance solutions for your company. Although they serve the same purpose, companies must consider some unique differences to choose correctly.

The best one for you depends on your circumstances, your business’s credit collection ability, and the level of confidentiality needed. Invoice discounting and factoring have different features and terms. Knowing the differences will help you determine which one will be the most beneficial for your business.

What is invoice factoring?

Invoice factoring is a short-term accounts receivable financing where you effectively use your outstanding invoices to secure financing for your company.

For many businesses, there is a gap between when you finish the job and send your client an invoice and when the client returns the payment. Invoice factoring can bridge this gap and help your business get the money sooner to tend to other expenses.

The terms of factoring deals are different in many situations. The debt factoring company can advance up to 80% of the value of the invoice. With factoring, the company may also partner in managing credit control of the business and processing invoice payments. This means your customers will be aware of your relationship with the factor, or they will know you are using invoice factoring as a short-term financing method.

Benefits of Invoice Factoring

Invoice factoring has some unique benefits that might appeal to certain organisations;

  1. First, the finance company partners with you to manage the credit, control the process, chase payments, and free up your time to manage the business. This can save the business valuable time and energy chasing invoices and instead focus on securing new clients and growing the business as the factoring company works on getting the invoices paid.
  2. Factoring companies provide excellent credit checking processes, making you more likely to trade with customers who pay on time.
  3. When working with a factoring company, you might be able to negotiate better terms with your suppliers because of the prompt payments.

The Downsides of Factoring

Invoice factoring has various benefits, but like everything else, there are some downsides as well, such as;

  • Your customers may prefer to deal with you directly instead of the factoring company.
  • A factor’s presence may impact the customer’s impression of your business, particularly if the factor handles the customer badly. You might even lose the customer.
  • Besides the financing, the additional services the factor provides may come at an extra cost. The management fees can take up to 0.75 to 2.5% of the turnover.

As a point of note, at Key Factors, we have been partnering with businesses for over 30 years, providing them with invoice factoring options. Our transparency of cost and focus on product delivery ensures that we deliver what a client and its customers would expect as a party to each transaction.

What is Invoice Discounting?

Invoice discounting is also a short-form financing method of borrowing against your outstanding invoices. It serves the same purpose of improving capital and cash flow. With invoice discounting, you maintain the responsibility of your sales ledger, payment chasing, and invoice processing. As a result, customers are unlikely to be aware of your relationship with the lender. However, this will only work when you have a diligent and capable accounting department.

Benefits of Invoice Discounting

Some of the benefits of going for invoice discounting include;

  • Invoice discounting can be arranged confidentially so your customers have no idea you’re borrowing against their invoices
  • You manage your credit control and debt collection for customer accounts, helping you build and maintain closer relationships with your customers.
  • Because no additional services are provided as with invoice factoring, invoice discounting may be cheaper than factoring.

The Downsides of Invoice Discounting

On the other hand, with invoice discounting,

  • You will need a strong and established in-house credit collection process to be accepted by an invoice discounting lender.
  • Invoice discounters only tend to work with businesses with higher levels of turnover and a positive net worth on their balance sheets. However, these terms can vary slightly depending on the discounter you choose to work with.
  • Some businesses become reliant on invoice discounting as a source of cash and cannot leave the arrangement without negatively impacting their sales and operations. Once more, this depends on the discounter you choose to work with.
  • Banks, in the main, offer invoice discounting and, as such, qualifications and lead times align themself with traditional lending parameters and timelines, which can turn into weeks and sometimes months before an answer is obtained from credit underwriters.

What are the differences Between Invoice Factoring Vs. Discounting

On the surface, invoice discounting and factoring look the same. They both involve borrowing against your unpaid invoices. Understanding the differences requires that you look deeper. Some of the differences you might uncover when you look deeper include;

Visibility and Control

  • With factoring, the finance company partners with you in the management of your sales ledger and credit control process. This may involve elements of the collection process, including chasing customer payments on your behalf. This saves businesses the time and cost of credit checking your customers, which is important if credit control has been poor in the past.
  • Invoice discounting lets you manage your own sales ledger and collect payments yourself. Because you retain control of the process, your customers should be unaware of the invoice discounting agreement. You get to manage your own sales ledger and collect payments yourself. Because you retain control of the process, your customers don’t know about the discounting agreement.

Adjustments to advances and funds available

  • With factoring, you are given advance funds for individual invoices. Any adjustments to the funds you receive are made on a day-to-day basis.
  • With invoice discounting, an invoice discount doesn’t manage your sales ledger. Normally, you have to provide a monthly reconciliation of the account that reflects any changes in the level of debt to be disallowed. The finance provider can then make adjustments to the funds that are available to you. So, rather than small daily adjustments, invoice discounts have larger adjustments that can be harder to manage.

Risks

  • Factoring is less risky to the lender because the factor manages the credit control and can assist in the collection process. Acceptance is virtually guaranteed. This is why factoring is a popular form of finance for businesses that are young, growing at a dramatic rate, or even, in some cases, hard up or threatened with insolvency.
  • Invoice discounting is riskier for the lender because there is no direct contact with your debtors. There is no control. Therefore, discounters only lend to businesses with a high turnover and a positive net worth on their balance sheets to reduce the risks. Some invoice finance companies may focus on the quality of the debtor book and even larger turnover to lessen the risks. The increased security allows businesses to get better rates and advances, so you don’t have to worry less about contractual ties, personal guarantees or debentures.

Industries that Favour Invoice Discounting and Invoice Factoring

Any business with invoices ranging from 30-90 days is typically a candidate for accounts receivable financing. Businesses with fewer clients owing a higher invoice value means there is a particular cash-flow vulnerability to late payments.

Some industries tend to utilise invoice discounting and factoring more than others, including;

  • Manufacturing
  • Logistics
  • Wholesale
  • Transport
  • Security
  • Recruitment
  • Printing
  • Construction

Invoice Discounting Vs Factoring: Which is Right for You?

Whether you choose invoice discounting or factoring depends on the nature of your business and its needs and creditworthiness. Your business’s size and ability to effectively manage your sales ledgers are also key considerations.

Small business owners who have encountered credit control and collecting payments in the past might find invoice factoring more beneficial because they can utilise the skills of the factoring company to assist with collecting or chasing invoices. This option is also valuable for small businesses because they can reallocate such resources to more effective functions to help your business grow. The downside is that it takes a bigger bite from your profit margins. Some providers may also insist on credit insurance.

Invoice discounting is more common among larger businesses with dedicated credit control and collection departments. Invoice discounting is also viable if you want to protect key customer relationships.

The Bottom Line

Getting funding for your business is vital. It is even more crucial to find the right funding methods that don’t compromise the future of your business. With invoice discounting and factoring, you have short-term funding options that are quick and effective. The money you get from these funding options is not restricted, and you can use it for various business expenses.

Invoice factoring might be a good idea for small businesses without a credit department. Using invoice factoring might help the business solve two problems at once. Invoice discounting is preferable for large businesses that can afford to chase the invoices and maintain proper credit checks on their customers. However, it’s not unheard of for large businesses to consider invoice factoring and vice versa.

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