Updated: 27th November 2020
Although the concept of factoring and invoice discounting is the same, the way in which they work in practice differs. The main distinction between the two types of invoice finance lies in who controls the sales ledger.
Before we look more closely at this and other differences, here’s a quick explanation of how invoice finance works in general terms.
Factoring and discounting are both forms of invoice finance that involve a lender releasing cash sums based on the outstanding sales ledger. They enable businesses to access regular amounts of working capital throughout the month, and are low-risk for both parties when compared with bank lending.
Invoice finance can help businesses to develop and grow, and with more specialist lenders entering the market, rates and fees have become competitive in recent years.
This is one of the main questions you need to ask yourself when considering invoice finance as a possible answer to cash flow problems. It is an important aspect for some businesses, with customer communications forming a large part of their overall ‘image.’
If this is the case, invoice discounting would be the better option of the two – you continue to chase outstanding payments, and the fact that you’re raising money on your customers’ outstanding debts remains confidential.
If customer communications are not an issue, factoring may better suit your business. All credit control procedures are handed over to the factoring company, which also releases time for you to focus on other areas of business.
Because you remain in control of sales ledger processes with invoice discounting, it generally remains confidential and your customers aren’t aware that a discounting agreement has been made. You chase and accept payments as normal, and there is no reference made to a third party on your discounted invoices.
Factoring is non-confidential – your customers are contacted by the factor for payment, and remittance is made directly to the lender.
Terms of the agreement
Factoring tends to be a longer-term finance solution. Lenders often require a long period of notice before you can exit an agreement, perhaps because they have taken on a bigger commitment by handling the sales ledger on your behalf.
Discounting on the other hand, carries with it less disruption on exit. It’s easier to end an agreement in terms of administration, but with both options you’ll need to manage the change-over period carefully if the agreement is cancelled.
Size of your company
Invoice discounting is often preferred by larger businesses with the capacity to operate their own credit control function. Factoring can benefit smaller companies that don’t have the same resources, and is often beneficial in that it frees up a considerable amount of time to spend on income-generating tasks.
If you’re unsure whether factoring or invoice discounting would be the better finance option for your business, give us a call at Real Business Rescue. We have wide experience in all industries, and can put you in touch with a variety of different lenders from small, specialist companies to larger institutions.