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Invoice Factoring vs Invoice Discounting: Differences and Similarities

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Invoice factoring vs invoice discounting
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Invoice factoring and discounting are similar in the sense that they are methods of financial invoicing. Invoice discounting is generally chosen by established businesses or collections departments; others opt for factoring.

For businesses that need improved and predictable cash flow, invoice finance could be a great option. There are several types of invoice finance, including invoice discounting and invoice factoring. 

When it comes to invoice factoring vs. discounting, what are the differences and similarities? Keep reading to find out.

What is invoice financing?

Invoice financing is a way to monetize your business’s outstanding invoices. Your business is essentially fronted a percentage of the invoice’s value by a third party in return for a stipulated fee (around 5% of the total value of the invoice). 

With this in mind, invoice financing allows businesses in need of a short-term cash injection to get paid immediately instead of waiting for a long time to collect payment from the customer.

There are two main types of invoice financing: invoice discounting and invoice factoring. Although their concepts are relatively similar, however, there are a couple of key differences to note.

What is Invoice Factoring?

This is a type of invoice finance that enables your business to “sell” some of its outstanding invoices. It is also known as debt factoring. In this case, a factoring company will pay your business around 80-90% of the invoice amount immediately after they receive it.

After the client pays the factoring company for the full value of the invoice, they will pay your business the remaining amount, minus their stipulated fee. Invoice factoring can create an excellent avenue for companies with large numbers of outstanding invoices to navigate cash flow problems and improve their revenue stability.

Here’s a great example of invoice factoring. You’ve just sent your book publishing client, George in New York an invoice for $5,000, payable in 60 days. The problem is, you need cash as soon as possible to buy new papers and printing plates. So you factor George’s invoice. The factoring company gives you $5,000, minus a few percent to cover their rates.

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What is Invoice discounting?

With the use of invoice discounting, the discounting company will lend your company a percentage of the money listed in the accounts receivable ledger. In plain terms, it is just like having an overdraft facility that is secured against your accounts receivables.

After raising invoices for your goods or services, the discounting company lends your business an amount equal to the full value of the invoices, with a small percentage. After you receive payment from your clients, you have to repay the loan plus the agreed-upon fee to cover the interest, risk, and cost (typically around 1-3% of the total invoice value).

Difference Between Invoice Factoring and Invoice Discounting

  •  In debt factoring, the client is aware that there is a third party involved, but in invoice discounting, this process is confidential, and the client is usually unaware that the business is using a financial provider.
  • The client is aware that the invoice is being factored when it comes to invoice factoring, but in invoice discounting, the client is usually unaware that the invoice has been discounted.
  • In invoice factoring, services like full sales ledger and collections service are available; however, in invoice discounting, these services are not included.
  • The factoring company is responsible for collecting invoices in debt factoring, but in discounting, the business itself takes responsibility for collecting the invoices.
  • In invoice factoring, the client pays the factoring company directly. In invoice discounting, the client pays the company as normal.

Similarities Between Debt Factoring and Invoice Discounting

  • Prevents issues in cash flow
  • Both can be used for late payments
  • They both involve selling your business invoices for cash
  • They are both very fast processes
  • They allow easier and faster access to money that would normally be tied up in your accounts receivable

Invoice Factoring vs Invoice Discounting: Which is Right for Your Business?

The plain and direct answer to this question is that it all depends on the type of business you run.

If you want more money for your invoices, factoring is a better choice. This is because it pays the full amount due to you and has fewer fees and costs. Invoice discounting will never pay out 100% of what you are owed unless there are added charges from the buyer beyond the percentage discount.

If however, cash flow is more important than the amount you receive, invoice discounting may be your best option. Your business will be paid immediately by the collecting company at a great price. These are factors each business owner will need to decide on.

Risks of Invoice Factoring vs. Invoice Discounting

Invoice finance is a generally safe form of business finance management. However, like everything involved in business, there are risks to look out for:

  • When it comes to invoice factoring, it is not as risky in comparison to invoice discounting
  • In invoice factoring, the factoring company handles the collection process and credit control. Businesses take on more risks by advancing their cash on the invoices without credit control from the lender.
  • Discount invoicing is more risky because it does not have direct contact with its debtor. Due to this high-risk factor, discount invoicing is mainly used by more established companies that make a turnover of around £100,000 and more, and have credit-worthy clients.

2 Advantages of Invoice Factoring and Invoice Discounting

1. Cost

For a lot of businesses, especially small businesses that do not have a finance department yet, the credit control services included in invoice factoring are a major added benefit. This is because they help free up time to focus on more important aspects of the business, instead of dealing with late payments.

On the other hand, these extra services require additional effort from the lender. In essence, invoice factoring is usually slightly more expensive than invoice discounting.

2. Flexibility 

When choosing between debt factoring and discounting for your business, flexibility is one of the main things you need to consider. With invoice discounting, the lender will typically require you to finance the entire debtor book. This is alright for a lot of businesses, but others would prefer to finance specific invoices, which is much easier to do with invoice factoring.

There is also a form of invoice finance known as selective invoice finance or spot factoring. This type of invoice finance allows you to choose specific clients, single invoices, or specific projects to fund. 

Selective invoice finance and spot invoice factoring are tasking to secure if your business is a small one or it hasn’t been in the establishment for long. However, it can be more flexible if your cash flow and revenue vary and your business is eligible.

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Conclusion

Most small business owners like having credit control services, because it helps to free up time and prevents late payments. For other business owners, they prefer to deal with directly on their own. Choosing between invoice factoring and invoice discounting all depends on the size of your business and revenue turnover. Just ensure to choose the invoice finance that would be most profitable to your company.

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Lilian Orji is an SEO content writer who helps small and medium enterprises in their business management, finance and growth. She's a contributor at EntrepreneurBusinessBlog.com. You can reach her via email, [email protected].

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