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Invoice discounting vs Invoice Factoring

Invoice discounting vs Invoice Factoring

What is invoice factoring?

Invoice factoring can be considered as a type of short term accounts receivable finance, I which you effectively ‘sell’ the outstanding invoices to some third-party i.e. a commercial finance company. In global trade it is often that there exists a gap between the finished task and invoice being sent and when the customer actually makes the payment and this gap has to be filled for business growth. In such situations invoice factoring adds value.

The terms of invoice factoring deals may vary as per the situations, but most in most of them factor provides you with 80 percent of the invoice value. You get your fund, and the factor takes on the responsibility to get payment from those clients, along with managing the credit control of the business, and processing invoice payments. This means that your clients will be known about your relationship with the factor. In other words, clients will know that invoice factoring is involved as a short-term financing method by the exporter/supplier.

What is invoice discounting?

Similar to invoice factoring, invoice discounting is also a form of short term borrowing against the outstanding invoices. It is generally used for improving a company’s working capital as well as its cash flow position. With invoice discounting, you are the one responsible for maintaining the responsibility for your sales ledger; payment chasing will be done by you, along with invoice processing. As a result, your clients will not be aware about the involvement of third party or your relationship with the lender.

Risk of invoice factoring vs invoice discounting

  • Invoice factoring is considered to be less risky for the lender as compared to invoice discounting because in invoice factoring the factor is responsible for managing the credit control along with debt collection processes. Thus, acceptance is virtually guaranteed.
  • Invoice discounting is considered much riskier for the lender because the lender has no direct contact with your debtors. They do not have any kind of involvement in the debt collection process. Thus, discounters typically lend to such businesses which have a turnover of about £100,000+ along with a positive net worth on their balance sheets to reduce the overall risk of non payment.

Advantages and disadvantages of invoice factoring vs invoice discounting

Both of these act as a medium for boosting your business cash flow. But both have their distinct advantages and disadvantages which lead towards the key difference between them.

Invoice factoring: Pros

  1. The finance provider will look after the sales ledger, will be responsible for managing the credit control process, and to chase payments, freeing up your time to focus on other business activities.
  2. Excellent credit checking processes are carried out by the lender which provides surety that you trade with customers that pay on time.
  3. Working with a factoring company can even help you in negotiating for better terms with your suppliers.

Invoice factoring: Cons

  1. Your clients might prefer to deal with you directly and not with some third party.
  2. The presence of a factor may impact the impression that the client has about your business, particularly if they have dealt with some not so good factors in the past.
  3. The services being provided by the factor comes at a cost. A factor may ask for anything from 0.75 to 2.5 percent of turnover. It depends upon the invoice factor provider that you have chosen.

Invoice discounting: Pros

  1. Invoice discounting may be arranged confidentially as the business itself chases the payment process, so your client will have no idea about the involvement of third party and about the borrowing against the invoices.
  2. You can manage your own credit control and debt collection for client’s accounts, which will help you to build and maintain closer relationships with your buyers.
  3. Invoice discounting is considered to be cheaper than invoice factoring.

Invoice discounting: Cons

  1. In order to get acceptance by an invoice discounting there will be need for strong and established credit collection process in your business.
  2. Invoice discounters generally work with businesses that have a turnover of £100,000 along with a positive net worth on their balance sheets.
  3. As you will have to chase the payment process along with various activities so it may impact your other business activities and can affect your overall sales and operations.

Invoice factoring vs invoice discounting

Differences Invoice discounting Invoice factoring
Suitable for Medium to large sized business Small to medium sized business
Typical initial advance 80% of the invoice value 85%-90% of the invoice value
control Your business The factoring company
Collection of payment Your business The factoring company
Known to customer Customer is not aware about the involvement of third party Customer is aware about the involvement of third party
cost Less expensive than invoice factoring More expensive than invoice discounting
Risky to lender More risky to lender Less risky to lender

Which is right for you?

Which will be better export finance option, factoring or invoice discounting? It depends on the business nature along with its particular needs. Typically your business’s size and its ability to effectively manage the sales ledgers will also be key considerations to choose one among these.

If you have a small to medium sized business that had certain problems with credit control and collection payments in the past, then invoice factoring will be a better option. It can act as a more solid solution for your businesses needs as it will provide you increased credit control services.

Invoice discounting is considered to be more common among medium to large sized businesses having lots of resources. They already have a well established and proven credit control processes. Thus they will not need the finance provider to perform collection of payments and other tasks as they can perform such tasks efficiently. Moreover, invoice discounting can be seen as a better solution if you want to protect customer relationships.