What is the difference between factoring and invoice discounting?

Factoring and invoice discounting are both financial services used by businesses to improve cash flow, but they differ in certain key aspects. Factoring involves the sale of accounts receivable to a third-party company known as a factor.

In this arrangement, the factor assumes the responsibility of collecting payments from customers and provides an immediate advance on the invoice amount, typically around 80-90% of the total value.

The factor then deducts a fee or discount from the remaining balance after collecting payment from the customer.

On the other hand, invoice discounting allows businesses to borrow funds against their unpaid invoices while retaining control over the collection process.

The company can access a percentage of the invoice value, usually up to 85%, as a loan from a lender. Unlike factoring, the business remains responsible for collecting payments from customers and repays the loan once the invoices are settled.

This key distinction gives businesses greater control and confidentiality over their customer relationships when using invoice discounting.

What is invoice factoring?

Invoice factoring is a financial service that allows businesses to improve their cash flow by selling their accounts receivable, or unpaid invoices, to a third-party company known as a factor. In this arrangement, the factor purchases the invoices at a discounted rate, typically around 80-90% of their total value, providing the business with immediate access to funds.

The factor then takes on the responsibility of collecting payments from the customers mentioned in the invoices. Once the customers make their payments, the factor deducts a fee or discount for their services and returns the remaining balance to the business.

Invoice factoring helps businesses bridge the gap between invoice issuance and payment receipt, providing them with the necessary funds to cover operational expenses, invest in growth, or manage any cash flow challenges they may be facing.

What is invoice discounting?

Invoice discounting is a financial service that enables businesses to access funds tied up in their unpaid invoices. Unlike invoice factoring, where the invoices are sold to a third-party factor, invoice discounting allows businesses to retain control over their invoicing and collection process.

In this arrangement, a lender provides a loan to the business based on the value of its outstanding invoices. Typically, the business can borrow up to 85% of the invoice value. The company continues to manage its own sales ledger and collects payments from customers. Once the customers settle their invoices, the business repays the loan amount plus interest or fees to the lender.

Invoice discounting provides businesses with a flexible and confidential way to improve cash flow by accessing funds that are tied up in unpaid invoices, without requiring the involvement of a third-party factor in the collections process

What are the differences?

Let’s explore some key distinctions between invoice factoring and invoice discounting:

Distinction #1:

Invoice factoring involves transparency with the customer, as they are aware that the invoice is being factored. Conversely, invoice discounting often maintains confidentiality, as customers are typically unaware that the invoice has been discounted.

Distinction #2:

Invoice factoring transfers the responsibility of collecting invoices to the factor, which is a finance company. In contrast, invoice discounting places the onus of collecting invoices on the business itself.

Distinction #3:

Invoice factoring introduces a third party into the equation, making customers aware of their involvement. In contrast, invoice discounting operates confidentially, allowing businesses to utilize a financial provider discreetly.

Distinction #4:

With invoice factoring, the customer makes payments directly to the factor-company. On the other hand, invoice discounting maintains the usual payment process, with customers paying the company directly.

Distinction #5:

Invoice factoring often provides additional services, such as full sales ledger management and collections service. Conversely, these supplementary services are not typically included in invoice discounting arrangements.

Risks of invoice factoring vs. invoice discounting

While invoice finance is generally considered a safe form of business finance, it’s important to recognize the varying degrees of risk involved.

Invoice factoring is a less risky option compared to invoice discounting. In factoring, the factor assumes the responsibility of credit control and collections. This reduces the risk for businesses as they receive cash advances on their invoices with the assurance of credit control from the factor.

In contrast, invoice discounting poses higher risk since businesses maintain direct contact with their debtors. Without the involvement of a lender in credit control, businesses bear more risk when advancing cash against invoices. As a result, invoice discounting is commonly utilised by larger companies with a turnover of £100,000+ and customers with proven creditworthiness.