What Is the Difference Between Factoring and Invoice Discounting?

If you want to get the best result with your company, you need to utilize every tool and weapon in your arsenal. You also need to be properly informed of the options and elements you have at your disposal. For this reason, we suggest you educate yourself on the difference between factoring and invoice discounting.

What is Invoice discounting?

Both invoice discounting and factoring are short-term borrowings directed against your outstanding invoices. They allow you to get some working capital, improve your cash flow, and create some freedom and flexibility for you business operations. Unlike factoring, here you are the one who is responsible for sales, payment checking, invoice processing…

Invoice discounting gives you a bit of extra confidentiality. Namely, your customers will not know that you are doing type of procedure. You also get more control over your accounts and collection. It is most often much cheaper than regular factoring.

However, you need to have a strong credit collection history, and the capability to actually get these invoices under control. If they feel like you can’t do this, the discounting lender will refuse to offer you his or her services.

What is Invoice Factoring?

Factoring is a way you can “sell” your outstanding invoices. It’s a type of short-term financing based on receivables, where you get to sell your invoices to third-party finance companies. Now, if you’re thinking how this is useful, think about the times when you had to wait for longer periods of time between when you finished a job with your clients and sent an invoice, and when you actually have the client pay said invoice. Factoring can close this gap, and help you get that money sooner.

Note that your customers will know that you are using factoring as a method for short-term financing, since the factoring company will actually communicate with the client.

Factoring gives you freedom. Since the factoring company will be the entity that observes ledgers, that will manage credit control systems, and that will focus on actually getting paid, you will have more time to focus on running your business. Furthermore, you can expect better terms with your suppliers, better results. They also do certain credit checking processes, so you will know, in the future, with whom you want to work with in the future.

However, problems relating to factoring usually boil down to customers simply wanting to only deal with you. You also need to rely on the factoring company to actually treat your customers well (or at least the way you want them to be treated). In other words—your relationship with your customers might change.

Finally, know that there are management fees for this kind of work, which can range from anything between 0.2% to 2%, if not more.

Control and adjustments

There are several difference between these two types of short-term financing. While any hiring the services of professional debtor finance companies that deal with this type of work on a regular basis to help you get the result you want, being at least familiar with these terms and their differences will help you get a better deal.

So, first things first—ease of adjustments to any cash or funds that you have. For factoring, your adjustments are done on a day to day basis. Discounting, however, is completely different. Since your sales ledger is not managed by the finance company when it comes to invoice discounting, but rather, by you yourself, you will have a bit more work to do here. You will have to provide regular monthly reconciliations of any account that may present changes and adjustments to the finance company for review.

You also have less control when you let a company do factoring activities for you. Namely, the finance company will take over the management of your processes, your sales ledger, and your credit control systems. Furthermore, they will also take over chasing customers, getting those payments for you (i.e. themselves). This is very useful for companies that have problems with credit control.

On the other hand, with discounting, you get more control. You might prefer this, or you might want to have the company doo all the work for you—it’s up to you.

Risk differences

Keep in mind that factoring is often far less risky for lenders because the company actually does all control and collection processes. In other words, you can be pretty sure that all acceptance will go through, and that you will get your money. Any and all business that are in trouble financially, or simply don’t want to miss out on a time-dependant and specific opportunity would get great results from this type of credit.

On the other hand, discounting is a bit risker. A discounting company does not have contact with your debtors, so they usually allow their services to business that have high turnovers, a positive net worth, and in general good business practices and success. They also take a look at debtor books. However, while it's difficult to get, they have better rates, and higher advances.

Conclusion

And there you have it, some core differences between factoring and invoice discounting. Keeping the above in mind, and focus on what works, and what doesn’t. Depending on your needs and the status of your company, you might need one, or the other. Take a good, hard look on where you stand, what your debt collection history is, and you should be golden.