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Invoice discounting vs. factoring: All the information you need

Updated: Sep 13

Does your business continually experience cash flow problems due to lengthy invoice terms and delayed customer payments?


If so, invoice finance could be the answer.


This type of asset-based lending is designed to scale with company growth and is available to businesses that sell products/services to other businesses (B2B).


It’s intrinsically linked to revenue, meaning the more money owed to your business, the more money you can advance upfront.


Over the years, challenger banks and digital lenders have innovated new models of invoice finance, helping to increase access to a wider range of businesses.


But while lots of products now sit within the umbrella of invoice finance, they tend to be variations of the main two types: invoice factoring and invoice discounting.


Though similar, there are key differences between the two that you need to be aware of.


Keep reading to explore invoice discounting vs factoring and get all the information you need to find the right solution for your business:

 

Invoice Factoring vs. Invoice Discounting

Invoice Factoring

Invoice Discounting

A model of invoice finance that sees a business sell its unpaid invoices in return for immediate payment.


After purchase, the factoring provider pays the business the majority of the invoice value upfront, clearing the remaining balance after the debtor has paid the invoice.


With factoring, the business relinquishes control of its sales ledger and collections, and debtors pay the factoring company directly.

A model of invoice finance that operates as an advance on money owed in outstanding invoices, secured against a business’ accounts receivable.


After receiving funding, the business repays the advance to the discounting provider plus pre-agreed fees and interest.


With discounting, the business retains control of its sales ledger and collections, and debtors make payments as usual.

Nuances in factoring and discounting models

Traditional invoice factoring and discounting models operate as whole ledger products, requiring businesses to advance their entire debtor book over a specific term (typically 12 to 24 months).


The information below provides a general overview of the main differences between invoice discounting and factoring. However, do remember that product variables have given rise to many nuances in how these different forms of funding work.


For example, business owners who want to avoid long-term contracts, or raising their complete sales ledger may be better suited to selective invoice finance products like spot invoice factoring or discounting.


Selective facilities allow you to submit single, or batches of invoices to advance as and when your business needs a cash flow boost.


The differences between factoring and invoice discounting:


1. Invoice ownership

  • Factoring: Under a factoring agreement, the provider purchases submitted invoices from a business, reassigning the debt to the factoring company.

  • Discounting: Under a discounting agreement, the business retains ownership of submitted invoices and debt owed.

2. Finance structure

  • Factoring: The provider buys submitted invoices outright, paying the business in two instalments. The initial payment typically releases 80 - 90% of the invoice value upfront. After receiving payment from the debtor, the provider pays the remaining amount to the business, minus any fees.

  • Discounting: The provider lends a percentage of the value of the business' submitted invoices at a pre-agreed discount rate. Once the debtor makes payment, the business repays the provider the advanced amount, plus any fees.

3. Credit control & customer payments

  • Factoring: Invoice factoring providers offer additional services, including credit control and invoice collection. In most cases, all aspect of credit control are assumed by the factoring company.

  • Discounting: With invoice discounting, the business retains responsibility for collecting customer payments and ensuring outstanding invoices get paid on time. collect payment from the customer.

💡 Note: To lower the risk of non-payment, discounting providers may require your business' debtors to pay invoices into a trust account. While the provider owns this account, it'll be set up in your business' name to maintain confidentiality.


4. Confidentiality

  • Factoring: A non-confidential facility. The factoring provider will send the business' debtors a Notice of Assignment (NOA) to make them aware of third-party involvement.

  • Discounting: A confidential arrangement that ensures a business' customers aren't made aware of any third-party involvement.

5. Risk

  • Factoring:

  • Default risk: The level of risk depends on the type of factoring agreement a business enters into. With recourse factoring, the business may be required to refund the money or buy back its invoices if the factoring provider is unable to collect payment from its debtors.

However, some invoice factoring providers offer a non-recourse factoring facility (also referred to as bad debt protection). Under this arrangement, the factoring provider assumes most of the risk of non-payment from a business' debtors.

  • Confidentiality risk: Not all business owners are comfortable with their customers being notified about the invoice finance arrangement, which is something factoring providers require.

  • Discounting:

  • Increased cost risk: As the discounting provider has less control over customer payments, they take on a higher level of risk, which may be reflected in the amount of money advance and the fees charged.

  • Default risk: Because invoice discounting is structured as an advance on the money your business is owed, the business is nearly always required to repay the discounting provider if its debtor defaults.


Infographic.


Invoice Discounting vs Factoring Infographic. Please include attribution to when using this graphic.
Invoice Discounting vs Factoring Infographic. Please include attribution to https://www.pennyfreedom.co.uk/post/invoice-discounting-vs-factoring when using this graphic.

Deciding between invoice factoring and discounting


As mentioned, technological advancements have led to far more factoring and discounting products and providers entering the UK market.


Bear in mind that there are considerable differences between invoice finance offerings, so it's important to compare individual product features before deciding whether factoring or discounting is right for your business.


Generally speaking, invoice discounting tends to be popular among larger businesses with already established credit control processes, while small businesses can often benefit from outsourcing their invoice collections through invoice factoring.


When debating invoice discounting vs factoring, or whole-book vs selective, consider:

  • Qualifying criteria: Minimum turnover, trading history, credit checks etc.

  • Terms of agreement: Contract duration, notice period, exit fees, minimum invoice volume requirements, default risk etc.

  • Customer relationships: Debtors' creditworthiness, confidentiality, late payments etc.

  • Credit control: Time spent on credit control, efficiency of existing internal processes, willingness to outsource etc.

  • Commitment: How often you'll be financing invoices, whether you're looking to advance specific invoices for a range of customers, or all invoices for specific customers etc.

Let's talk.

If you'd like to discuss the best course of action for your business, Penny can help. Contact customer support and a member of the team will be in touch to talk through your options.



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