Invoice discounting and factoring are similar in the sense that they are both methods of invoice finance.
Debating whether factoring or invoice discounting is dependent on the efficiency of credit collection, accounts and book debt department.
Invoice discounting is generally chosen by established business or collections departments – others opt for factoring.
What is invoice factoring?
Invoice factoring is a type of accounts receivable finance that is also known as ‘factoring’ or ‘debt-factoring’.
Invoice factoring enables businesses to sell outstanding invoices (accounts receivable) to a third-party commercial finance company (a factor).
The factor (finance company) then buys the invoices for a percentage of the total value – between 60% and 80%. The factoring company then take responsibility for collecting the invoice payments, managing credit control of the business and processing invoice payments.
Invoice factoring has become an alternative to business funding, gaining popularity for businesses with imperfect credit.
What is invoice discounting?
Invoice discounting is one of the simpler forms of invoice finance.
Invoice discounting is a short-term borrowing against outstanding invoices – it enables you to sell unpaid invoices to a lender, who then gives you a cash advance based on the percentage of the invoice’s value.
The lender then gives you the remaining balance after your customer pays the invoice.
This form of financing is used to help improve cash flow. Invoice discounting benefits a company’s working capital and cash flow position as roughly 80% of the advance invoice can be converted into cash.
What are the differences?
In invoice factoring the customer is aware that the invoice is being factored. In invoice discounting the customer is not aware that the invoice had been discounted.
In invoice factoring the factor (finance company) is responsible for collecting in invoices. In invoice discounting the actual business takes responsibility for collecting the invoices.
In invoice factoring the customer is aware that there is a third party involved. In invoice discounting the process is confidential and your customers won’t be aware you are using a financial provider.
In invoice factoring the customer pays the factor company directly. In invoice discounting the customer pays the company as normal.
In invoice factoring, services like full sales ledger and collections service are available. In invoice discounting, these services are not included.
Risks of invoice factoring vs. invoice discounting
Invoice finance is a relatively safe form of business finance – but like anything, there are risks involved.
Invoice factoring is less risky compared to invoice discounting.
In factoring, the factor manages the credit control and collection process. Without credit control from the lender, you are taking more of a risk by advancing your cash on the invoices.
Discounting is riskier because you do not have direct contact with your debtors. Due to the higher risk, discounting is typically used by bigger companies with a higher turnover – £100,000+ – and creditworthy customers.