When a company runs short on cash flow, they often turn to business loans to fund their daily operations. But for business owners who aren’t too keen on taking on additional debt, invoice financing may be their best option. Invoice factoring and invoice discounting are two of the most common forms of invoice financing. Unfortunately, many business owners cannot distinguish the difference between the two.
What is Invoice Factoring?
Invoice factoring is a financing option where a business ‘sells’ their pending invoices to third-party companies at a discount. The terms and conditions involving invoice factoring usually vary, but a majority of factoring companies provide between 60% to 80% of the total value of an invoice.
Invoice factoring removes a lot of the worry surrounding the managing of your invoices. Factoring companies take on the responsibility of overseeing credit control, processing invoice payments, as well as collecting payments from your customers.
What is Invoice Discounting?
Much like factoring, invoice discounting is a short-term financing option where business owners borrow money against pending invoices. Entrepreneurs often use invoice discounting to help improve working capital and cash flow.
Invoice discounting allows you to retain control over your sales ledger, payment collections, and invoice processing. Unlike invoice factoring, your customers will remain unaware of the transactions between you and the lender.
What are the Main Differences Between Invoice Factoring and Discounting?
Both invoice factoring and discounting involve borrowing against pending invoices. However, the main difference between the two can be narrowed down to the one who controls the sales ledger and collects the payment from customers. To be more specific, here is what differentiates one from the other.
Business owners primarily consider flexibility when choosing the best financing option for their businesses. With invoice discounting, potential lenders often request that you finance all your current pending invoices. While a good many companies agree with this, there are others who prefer only to finance specific invoices. If you decide you would rather not finance all your pending invoices, the ideal choice for you may be invoice factoring.
Invoice discounting is also known as ‘confidential invoice discounting’. As previously mentioned, your customers wouldn’t have to know you’re using the services of an invoice financing company. With invoice discounting, it’s business as usual. On the contrary, factoring companies deal directly with your customers. This means your clients will know you’re using invoice financing.
Since a potential lender loans funds without the assurance of getting repaid, the risk is a crucial factor in every type of financing. Without credit control, lenders take on more risk by advancing money against your invoices. For this reason, discounting is often used by larger businesses with higher turnover and creditworthy clients. Invoice factoring, on the other hand, is commonly used by smaller businesses.
Invoice factoring is more suitable for smaller companies that don’t have the staff and resources to fully implement comprehensive accounting processes. Invoice discounting, on the other hand, works better for companies that have financial and credit controls in place, as well as internal audit procedures.
With invoice factoring, the lender you’re with will be the one to manage your sales ledger and credit control process. They will also take on the responsibility of collecting invoice payments on your behalf. This helps you save time and money because you don’t have to pay for credit checks on your clients.
On the contrary, invoice discounting allows you to continue collecting customer payments and managing your sales ledger. Since you remain in control of the process, your customers wouldn’t have to know that you’re using invoice discounting.
For companies that don’t have a finance department, you can benefit from the credit control services that come with invoice factoring. This allows you to free up time so you can focus on running your business. You don’t have to deal with late payments and credit checks because the factoring company will do it for you.
However, the additional services will require more effort from the lending company, which means that invoice factoring is often more expensive than invoice discounting.
Which Financing Option is Right for You?
Choosing between invoice factoring and invoice discounting shouldn’t be as overwhelming as it seems. The type of financing you choose will depend on the size of your company, as well as your sales ledger management needs.
If you run a small company and your resources are limited, you can use the credit control and payment collection service that comes with invoice factoring to your advantage. On the other hand, larger companies with a debt collection process in place or if you want to handle your own sales ledger, invoice discounting may work better for you.