What is Invoice Discounting?
Invoice discounting allows a business to take a loan against its unpaid invoices from a financial institution (usually a bank or a discounting firm). The financial institution lends up to 95% of the total invoice value in advance for a fee. The remaining invoice payment is collected from customers by the business. Invoice discounting is also known as invoice financing.
What is Invoice Factoring?
Invoice factoring is a financial agreement in which a business sells its invoices (also called account receivables) to a factoring company at a discount. With invoice factoring, a business gets access to immediate cash flow instead of waiting for months for the invoices to get paid. Companies use invoice factoring for many reasons, the main one being able to deal with their immediate expenses so the cash flow doesn’t get disrupted.
The factoring company pays a large portion of the invoices up-front (typically 70-90%) while the remainder is paid (minus fees) once the invoice amount is collected in full. The factoring company takes responsibility for collecting payments from the customers.
The key difference between invoice discounting and invoice factoring is who collects invoice payments from customers. In Invoice discounting, the business is responsible for collecting and handling payments whereas, in invoice factoring, the financial institution bears the responsibility.
Difference Between Invoice Discounting and Invoice Factoring
| Aspect | Invoice Discounting | Invoice Factoring |
|---|---|---|
|
Ownership of Debt |
Business retains ownership of invoices, uses them as collateral. |
Sells invoices outright to the factor. |
|
Control of Collections |
Business retains control over collecting payments |
Factoring company is obligated to collect remaining payments. |
|
Customer Relationship |
Direct interaction with customers for payments. |
Factoring company interacts with customers for payment collection. |
|
Interest/Fee Structure |
Interest-based financing with fees on the loan. |
Fee deducted from the invoice value by the factoring company. |
|
Risk Exposure |
Business takes on the risk if customers don’t pay. |
Factoring company assumes the risk for unpaid invoices. |
Choosing Between Invoice Discounting and Invoice Factoring
Choosing one of the two options can sometimes become tricky. Keeping your business size and model in mind, you should compare invoice discounting and factoring in detail and see what’s right for your business. But for now, we can help you with choosing the right option.
- Invoice Discounting: Ideal for businesses wanting to retain control over customer relationships and collection processes while using invoices for immediate cash flow.
- Invoice Factoring: Suitable for businesses seeking to outsource payment collection and credit risk while unlocking immediate cash flow.
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FAQs
Invoice discounting is ideal for businesses that want to maintain control over their customer relationships. It’s used by businesses that have strong sales but need quicker access to cash flow for the growth of their business.
Factoring companies can typically lend up to 95% of the total invoice value. The exact percentage will depend on the provider and the specific agreement you have with them.
Yes, invoice factoring can potentially impact customer relationships because the factoring company takes over the payment collection process. If the payment process is handled poorly, it can give customers the impression that your business is struggling financially.
In invoice factoring, the factoring company buys your invoices and takes full responsibility for collecting payments from your customers.
In invoice discounting, your business keeps control of the invoices and collects payments directly from customers.
