Invoice Factoring vs Discounting

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Businesses can release inaccessible funds tied up in outstanding invoices using invoice financing processes such as invoice factoring and invoice discounting.

Invoice factoring or discounting could be a solution for small businesses that need to tackle cash flow concerns or pay for unexpected costs.

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With either of these financing options, you can get capital for your company using outstanding bills. Therefore, invoice financing could be a brilliant option if your company needs a better, more reliable cash flow.

However, do you know which is more effective when comparing invoice factoring and Invoice discounting?

While invoice factoring vs discounting are frequently misunderstood, the two procedures have different structures and repayment processes.

Here’s everything you need to know!

Invoicing Factoring and Discounting (Meaning and Example)

What is the meaning of invoice factoring?

Invoice factoring commonly referred to as “factoring” or “debt-factoring,” is a type of accounts receivable financing.

It allows companies to sell their outstanding invoices (accounts receivable) to a third-party accounts receivable finance company (a factor). 

The factor (invoice financing company) then purchases the invoices for a percentage of the entire value, typically between 60% and 80%.

Following that, the factoring company will be in charge of processing invoice payments, monitoring the business’s credit management, and collecting invoice payments.

Invoice factoring has become increasingly popular as a corporate funding choice for companies with poor credit.

A basic example of invoice factoring

Invoice factoring is by far the most convenient type of financing. However, it takes place in two phases.

Around 80% of the entire amount of the company’s unpaid invoices arrive in the first phase. When all of the payments are made by the clients to the lenders, the lender will then reimburse the remaining 80% after deducting its fees (20%).

Consider the following scenario: ABC Corp has $5000 in receivables that are due in 90 days.

In order to obtain invoice financing for its receivables, company ABC Corp. goes to bank/financial institution XYZ. Instead of waiting 90 days to request payment from its clients, it asks for money immediately.

After conducting a thorough investigation of the creditworthiness of ABC Corp’s clients, XYZ chooses to lend $4250 to ABC Corp., or 85% of the total amount.

The remaining 15% will be paid back by XYZ after subtracting its fees once it has collected the full $5000 from ABC Corp’s clients. This means that XYZ will charge $200 in fees while returning $550 to ABC Corp.

In conclusion, ABC Corp. was charged a fee of $200 and was able to promptly meet its working cash needs without having to wait for its clients to reimburse it.

What is the meaning of invoice discounting?

Another simplest type of invoice financing is invoice discounting, which involves taking out a short-term loan on unpaid invoices.

What is the meaning of invoice discounting

In essence, you can use it to sell outstanding invoices to a lender, who will then grant you a cash advance based on a certain portion of the invoice’s worth. 

Once your customer has cleared the invoice, the lender will then release the remaining funds to you. This type of financing is employed to assist in increasing cash flow. 

With invoice discounting, a company can convert about 80% of the advance invoice into cash, which is advantageous for working capital and cash flow.

A basic example of invoice discounting

In the case of invoice discounting, the business that is requesting money is in charge of collecting payments from its clients.

Consider the following scenario: ABC Corp has $5000 in receivables with a 45-day due date and requires immediate cash to cover staff salaries.

In order to secure quick financing, the company ABC Corp. goes to bank XYZ presents its receivables invoices and offers to pay a fee of 3%. Bank XYZ lends $4000, or 80% of the outstanding receivables.

Therefore, without having to wait 45 days, company ABC Corp. receives $4,000 to cover its expenses. The clients of ABC Corp then repay their $5,000 dues back to them.

Following that, ABC Corp. sends $4,150 to XYZ and keeps the balance. 

Overall, XYZ receives its own funds back, plus $150 (3% of $5,000) in fees.

Difference Between Invoicing Factoring and Invoicing Discounting

We now understand that invoice financing includes both invoice factoring and invoice discounting, which extend funds against unpaid receivables.

Nevertheless, there are a few significant differences:

Parameters Invoice factoring Invoice discounting
Suitability Invoice factoring is suitable for small and medium-sized businesses. Invoice discounting is ideal for medium-sized and larger businesses.
Credit control The company’s sales ledger is completely under the control of invoice factoring service providers. The sales ledger of the business is not within the control of invoice discounting service providers.
Anonymity Because customers pay directly to the factoring service provider, there is no anonymity while using this financing option. In this case, the cash ledger is kept in strict confidence. Most of the time, customers are unaware that an invoice discounting service provider is involved.
Value raised Through factoring, one can raise up to 80% of the unpaid balance. The value of the accounts receivable and the creditworthiness of the company determine how much money is issued against bills.
Collection On behalf of businesses, the factoring service provider is in charge of receiving payments from clients. The company is in charge of obtaining payment from its clients with the involvement of the invoice discounting service provider.
Cost It can occasionally be less expensive than invoice discounting. It costs a little more if the loan is non-recourse.

Businesses can choose between invoice factoring and discounting based on the abovementioned information to determine which is best for them.

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To choose the most appropriate one, companies must take into account their capacity for repayment, the creditworthiness of their clients, and credit management measures.

Anyway, whichever option you choose, you will have to deal with multiple invoices. As a business, you can waste your time creating hundreds of invoices manually, can you?

Creating invoices manually can also introduce human errors and lead to delayed payments as well. 

Therefore, to avoid such misfortunes, you must switch to creating your invoices fast and with complete automation with a software solution such as InvoiceOwl.

With InvoiceOwl, creating, managing, and tracking invoices is easy and convenient. Additionally, it also helps you get paid faster.

Say Goodbye to the Old Method of Creating Estimates & Invoices

Try InvoiceOwl to create professional-looking estimates & invoices and get paid faster!

Benefits and Drawbacks of Invoice Factoring and Invoice Discounting

Benefits of invoice factoring

  • It is a quick and secure way to meet your financial demands for working capital.
  • Because the invoice factoring company is responsible for collecting the receivables, it can reduce the time needed for management and collecting payments from clients.
  • In terms of difficult credit markets, it is easier to obtain funding with invoice factoring.

Drawbacks of invoice factoring

  • The fact that a third-party lender (factoring company) is now in charge of collecting payments may have an impact on your relationships with your clients.
  • In comparison to other bank loans, the fees are higher, and they also depend on the creditworthiness of your customers and receivables.

Benefits of invoice discounting

  • Invoice discounting accelerates cash flows because you don’t have to wait for payments from customers.
  • Invoice discounting is done in a discreet manner to avoid affecting your relationships with your customers.
  • Although you might have been turned down for other loans, it’s simple to obtain funds with invoice discounting.

Drawbacks of invoice discounting

  • The task of collecting the payments from clients remains your responsibility.
  • If the clients don’t pay on time, the penalties for making late payments to your lenders could skyrocket.

Industries Accepting Invoicing Factoring and Discounting

Any company that issues invoices between 30 and 90 days would be a suitable fit for accounts receivable finance.

Additionally, a company’s cash flow is more prone to late payments if it has fewer customers who owe a higher invoice amount.

Compared to other industries, invoice finance is typically used more frequently in the following ones:

  • Printing
  • Recruitment
  • Construction
  • Manufacturing
  • Logistics
  • Security
  • Transport
  • Wholesale
Frequently Asked Questions
  1. Is invoice factoring an option worth considering?

    For companies in need of quick cash, this financing solution works effectively. An established business with creditworthy customers and the financial capability to cover processing fees can benefit from it.

  2. What similarities exist between invoice factoring and invoice discounting?

    Both are a type of invoice financing and aid in sustaining cash flow for businesses. Additionally, it enables businesses quick access to capital.

  3. What distinguishes bill factoring from bill discounting?

    When a bill is discounted, the customer pays the balance in advance at a reduced rate. In the case of factoring, on the contrary, businesses sell their outstanding bills to a third party at a discounted rate.

Which is Better?

Invoice factoring vs. invoice discounting: Which is a better alternative for financing accounts receivable?

It depends on the specific needs of your company and how it operates. Another critical variable to consider is the business’s size and your capacity for managing your sales ledgers.

For companies that don’t mind giving up management of their invoices and letting the invoice factoring company collect payments from clients, invoice factoring is a smart alternative.

It can be especially helpful for smaller businesses that lack the funding to dedicate to tracking down unpaid invoices.

Factoring may be simpler to qualify for if you’re a new company or have poor credit because it depends more on the credit histories of your customers. But there’s a chance that the costs will be higher.

However, companies who want to keep control of their accounts receivable might consider invoice discounting as a better alternative.

Invoice discounting can be a very rapid and even inexpensive financing option if you have a strong relationship with your clients and can promptly collect your unpaid invoices.

By leveraging invoice discounting, your small business can boost its cash flow and use that money to pay its suppliers and staff or invest in some other areas of the company’s business operations.

Author Bio
Jeel Patel
Jeel Patel

Jeel Patel is the founder of InvoiceOwl, a top-rated estimating and invoicing software that simplifies the invoicing and estimating processes for contractor businesses. Jeel holds a degree in Business Administration and Management from the University of Toronto, which has provided him with a strong foundation in business principles and practices. With understanding of the challenges faced by contractors, he conducted extensive research and developed a tool to streamline the invoicing and estimating processes for contractors. Read More