Invoice Discounting vs Factoring

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    What is Invoice Factoring?

    This is short-term accounts receivable financing, where you sell your unpaid invoices to a third-party commercial finance company. You might find there’s a gap between when a job is completed and you send an invoice, and when the client makes payment – this is where invoice factoring adds value.

    Depending on the situation, the terms of factoring deals can be different -however most factors advance businesses anywhere from 60 to 80 percent of the value of the invoice. This means you will receive your cash, and the factor is responsible for getting payment from customers who haven’t yet paid, handling the credit control of the business, and processing payments of the invoice. Your customer will then be aware of your relationship with the factor, and know that you are using this as a short-term financing method.

    What is Invoice Discounting?

    This is a form of short-term borrowing against the outstanding invoices, similar to business invoice factoring. It helps improve working capital and cash flow position within a company. You do however maintain responsibility for sales ledgers, chasing payments, and processing your invoices. This way, your customer is less likely to be aware of your relationship with the lender.

    Invoice Factoring Vs Discounting: What are the differences?

    • The sales ledger and credit control process is taken over by the finance company when factoring.  Which means they chase your customer payments on your behalf, allowing you to save time and the cost of credit checking customers – vital if past experience shows poor credit control. 
    • Invoice discounting means that you handle your own sales ledger and collect any payments yourself. That way your customers are likely to be unaware of the agreement.
    Advances and funds available adjustments
    • Adjustments to the funds received are altered on a day to day basis with factoring – you get advanced funds for individual invoices.
    • Invoice discounters do not manage your sales ledger, so you have to supply monthly reconciliations of the account showing it there are changes in the debt to be disallowed. The provider can then make adjustments to the funds available to you but it can be more difficult to deal with.
    Risks of Invoice Discounting vs Factoring
    • The factor manages the credit control and collection processes which make factoring less risky for the lender – and acceptance is virtually guaranteed too. It is a popular form of finance for those businesses which are struggling.
    • As there is no direct contact with the debtors, invoice discounting can be riskier – leaving them with no control. Discounters generally only lend to businesses with a high turnover (£100,000 and upwards) to reduce the risks. Because of the increased security, you find that businesses generally receive better rates.

    Advantages and Disadvantages of Factoring Vs Discounting

    Both are a quick way to improve your cash flow, and have clear advantages and disadvantages:

    Factoring: The advantages…
    1. Sales ledgers, credit control and the chasing of payments are handled by the finance company, freeing up your time to focus on your business.
    2. The credit checking process means you are more likely to do business with reliable customers who make payment on time.
    3. It can help with supplier negotiations.
    Factoring: The disadvantages…
    1. Customers may rather deal with you only.
    2. If customers have a bad experience with the factor, it could reflect poorly on you.
    3. There is a cost for any additional services from the factor. They can ask for anything from 0.75 – 2.5% of turnover.
    Invoice discounting: The advantages…
    1. This is a confidential process, so customers are unaware you are borrowing against their invoices.
    2. It is good for building and maintaining customer relationships as you can handle your credit control and debt collection,
    3. It is cheaper than factoring.
    4. Modern providers means there is less of a risk to directors.
    Invoice discounting: The disadvantages…
    1. In order to be accepted by a lender, you will already need a strong and established credit collection process in-house.
    2. They only really work with businesses with £100,000 turnover and positive net worth.
    3. It can have a negative impact on the sales and operations of a business as they end up relying on invoice discounting as a way to source cash.

    Which Industries Choose Factoring and Invoice Discounting?

    Certain industries prefer invoice finance over others, including:

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

    What is right for your business?

    Well, this depends on the business that you run, and its needs. You should also consider the business’s size and ability to effectively manage the sales ledgers.

    Factoring is a better option for example if you have a smaller sized business which has had problems in the past with credit control and collecting payments. It does provide a better credit control, however it will take a bigger chunk out of profits.

    Larger businesses tend to use invoice discounting, this is because they already have an established and proven credit control processes. It’s also a better solution for maintaining key customer relationships.