Invoice discounting and factoring are both methods of invoice finance. Invoice financing is a great option if your business needs improved cash flow and both discounting and factoring are ways in which businesses can do this. In this article, we will be discussing the differences between invoice factoring and discounting and everything you need to know about invoice financing.
What Is Invoice Financing?
Before we go into the different types of invoice financing, it is good to know what invoice finance actually is. Invoice financing is a way for businesses to borrow money against unpaid invoices from their clients or customers. Invoice financing is a way for businesses to help improve their cash flow, pay their employees on time and reinvest money into their business for growth opportunities. Businesses will usually pay a fee to the company who are lending the money, however even with the fee, it is a great option for businesses to solve invoicing problems.
What Is Invoice Factoring?
Invoice factoring is a type of invoice finance where a business will sell its unpaid invoices to a third party company. The third party company will then take on the responsibility for collecting the outstanding amounts that are owed. The factoring company will likely pay you around 70 – 90% of the invoice amount upfront, and then once the invoice has been paid to the factoring company, they will give you the remaining balance once they have deducted their fees and charges.
What Is Invoice Discounting?
Invoice discounting, on the other hand, is a financing method that allows businesses to borrow money against the value of their unpaid invoices. Unlike invoice factoring, the business will remain in control of collecting the invoices from their customers. The lending businesses will offer a loan based on the value of any outstanding invoices, then once you have received payment from your customers, you will repay the loan plus an agreed fee.
Invoice Factoring vs Invoice Discounting
Invoice factoring and invoice discounting are both great ways for businesses to borrow money against their unpaid invoices, however there are differences between the two that could be beneficial for different businesses. Invoice discounting is a loan against your outstanding invoices whereas with invoice factoring, the factoring companies will purchase your unpaid invoices from you and collect the payments.
Advantages Of Invoice Factoring
- Immediate cash flow – factoring provides companies with quick access to money, allowing businesses to cover their operating expenses promptly, pay their staff on time and invest in growth. This can be especially useful for smaller businesses who do not have a huge amount of cash accessible.
- There are no debts incurred – because the business is selling its invoices, and not taking out a loan, there is no debt burden and this can be particularly beneficial for businesses that do not have a credit history.
- Outsourced collections – the factoring company will take charge of collecting payments from your customers, this will relieve the business from the administrative task of chasing any overdue payments from their customers
Potential Drawbacks Of Invoice Factoring
- Cost – the factoring company will charge you fees and these can be higher than traditional bank loans, potentially impacting the overall profitability of the business
- Customer perception – some customers may view invoice factoring as a sign of financial instability and this could potentially affect business relationships, having other businesses chase for invoices could also lead to potential negative perceptions of your business, especially if the factoring company takes extreme measures when chasing for payments.
Advantages Of Invoice Discounting
- Customer confidentiality – since the businesses customers will be unaware of the financial arrangements of the invoice discounting, businesses are able to maintain their customer relationships and handle all customer payments and collections as usual.
- Lower costs – as the business retains the collection responsibility, invoice discounting can be a more cost effective option compared to invoice factoring
Potential Drawbacks Of Invoice Discounting
- Eligibility – banks and other institutions that offer invoice discounting may have stricter eligibility and this may make it more difficult for smaller businesses or those with weaker credit profiles to obtain invoice discounting.
- Payment collection – with invoice discounting, the burden of collecting outstanding payments from customers lies with the business and this can often require dedicated resources and time.
Choosing The Right Invoice Financing Method For Your Business
When choosing between invoice factoring and invoice discounting, it will entirely depend on the circumstances and preferences of your business. Invoice factoring is often used by small businesses when immediate cash is needed and the cash flow is in a potentially critical position. Invoice discounting can be riskier and this is why it is generally used by larger companies that have a steady and reliable customer base. However, ultimately the decision is based solely on the needs of the business. Both invoice factoring and invoice discounting present viable solutions to businesses that are facing potential cash flow problems. By carefully considering the potential advantages and drawbacks of each option, businesses can make an informed decision that will lead to improved cash flow and overall financial stability.
How New Millennia Can Help
At New Millennia, we provide an alternative to financing that is predominantly designed for start ups and small to medium sized recruitment agencies. Unlike the solutions explained above, New Millennia provide a funding solution which removes all of the personal risk (such as personal guarantees). We also provide a 100% funding solution meaning you are not restricted by the growth of the business and will not get penalised for having high volumes with selected clients.
We take away all of the financial risks that are associated with traditional invoice discounting/factoring which will allow you to concentrate on winning business and providing the service to your clients without having the worry or headaches which traditionally come with the solutions mentioned above.
If you have any questions about our alternative factoring solutions, get in touch with us today and we will be happy to help!
