November 16, 2023

When it comes to understanding the differences of invoice discounting vs factoring, it can seem at first as if they’re almost the same as one another. While the two share a lot of similarities however, there are a few key differences between them. It’s important to think about what it is that your business specifically needs before applying for financing services. There are multiple options open to businesses, with some more suitable than others.

What is invoice factoring?

Invoice factoring is a useful financing option for businesses wanting to improve their cash flow situation. In essence, if your company has any outstanding invoices, you can sell them to a factoring business, who will give you an upfront cash sum in return.

Why would anybody buy my outstanding invoices?

If your business is waiting on a large payment from a client, it can be frustrating to have to wait for 90 days, or however long they are entitled to pay you by. This frustration can double if your business is experiencing cash flow issues at the same time.

Outstanding invoices still carry value, but they need time for that value to be realised. While your business may struggle to wait for these invoices to be paid, others have reserves large enough to absorb the risk and receive the payment later. These are invoice factoring providers.

How does invoice factoring work?

Factoring companies do actually purchase your invoices from you, making it their legal obligation to chase up any outstanding payments. When you use a factoring company, your client then has to pay them instead of your business.

These companies will typically buy your invoices for around 80-90% of the value, and send through the money within days. Once that is done, your interaction with the client and their outstanding invoice can end, as the factoring company will assume all responsibility for it.

Once the factoring company is paid by your client. They’ll send over any remaining money, minus a small fee for their services (typically a percentage of the total invoice amount).

Benefits of invoice factoring

Usually quicker than a loan

The purchasing of your invoices is a far more straightforward task than checking through your company’s credit history and finances. As such, you can usually expect money in your account within days rather than weeks.

Releases liability

You have no need to do anything once the invoices have been sold. The factoring company will chase up any invoices that aren’t paid up, and absorb that risk when they make the purchase.

Drawbacks of invoice factoring

Company image

As your client will now need to pay the factoring company, you may worry how that may be interpreted by them. Many businesses use factoring to quickly free up their cash flow, but potentially it could be regarded as an act of a business in distress. An introductory email to your client about your new ‘payment partner’, however, is often innocuous enough to maintain the confidence of your clients.

You may have to wait a while for the remainder

Because your business has relinquished control of the invoices, you’ll have to wait till the factoring company has received and processed your client’s payment before you receive what’s left. As they typically pay out 90% as a lump sum, the remainder (sans service fee charges), only hits your account after the factoring company has been paid.

What is invoice discounting?

Invoice discounting is similar to factoring in the sense that your outstanding invoices are treated as an asset that can be cashed in. The crucial difference between the two though, is the fact that you retain responsibility for the invoices being paid.

Instead of purchasing the invoices from your business, an invoice discounting company provides a loan based on the amount that they can see you’re due to be paid. Your client is still paying you, and as such, you’ll have to chase up any overdue invoices.

How does invoice discounting work?

By looking at your invoices, an invoice discounting company can see that your business is due to receive enough money to cover the advance they give you. The risk they take, however, is not in whether or not your client pays their invoice, but rather whether you will pay them back.

Unlike a normal loan, invoice discounting companies don’t make their money on interest rates attached to monthly payments. Instead, they expect that when your invoice is paid, they’ll receive their money back from your business in one lump sum, with a service charge added on top.

Benefits of invoice discounting

Quick access to money

You can typically have the money in your account within 48 hours with invoice discounting. There are far fewer checks and less paperwork to work through than you’d experience when applying for a loan.

Can speed up growth

If your business is waiting on the payment of a few large invoices before it can begin to look at growth plans, invoice discounting can speed up the whole process.

Drawbacks of invoice discounting

Only for B2B companies

Invoice discounting companies partly exist because businesses are far more likely to pay their invoices than a single member of the public. As such, you won’t be able to use this method for B2C invoices.

Similar liability to a standard loan

As invoice discounting companies don’t actually buy the invoices from you, your business still holds the responsibility for making sure they’re paid up. If they aren’t, you’ll still need to find a way to pay back the sum you received plus the service charge.

Invoice discounting vs factoring: which is better?

It completely depends on your business needs, as both methods have their own pros and cons. Both though, have an advantage over traditional loans in that they’re easier to be accepted for. Financiers only need to see the invoices you have to realise that you’ll soon have the means to cover their costs.

When it comes to choosing between the two, it often comes down to how much control owners want over their invoices. Discounting allows you to take charge of any chasing up you might need to do, whereas factoring takes it completely out of your hands. Some may worry about how selling their invoices might look to clients, and opt for discounting instead. As mentioned earlier though, it can be easy to keep clients’ minds at ease, with a simple email explaining who they need to pay.

Both financing methods can act as an absolute lifeline for small businesses. With reasonable service charges, and almost instant payment, B2B companies should always have such methods in mind to avoid potential cash flow issues.

Need business funds quickly?

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Find out what the best financing options for your business are. Give in touch with one of our friendly advisors for FREE, no-obligation advice. Call on 0800 975 0380 or email advice@forbesburton.com