Invoice factoring and invoice discounting are types of invoice finance products. Invoice finance is a finance product that allows you to release funding from your unpaid invoices on a flexible, short-term and revolving credit basis.
How does invoice finance work?
All types of invoice finance work in a similar way with some key differences in how they are administered. Most invoice finance products are for the whole sales ledger although some providers may offer selective invoice facilities where you can select which invoices to finance. Once you raise your invoices you share or send them to the invoice finance provider and they will normally provide the funding within 24 hours into your bank account. The amount of funding offered can vary but it is typically between 80-90% of the invoice value (although it can be as high as 100%).
The invoice is sent to the customer as normal and the customer remains on their usual payment terms whether that is 30, 60, 90 or 120 day payment terms. When the customer pays the invoice the payment will normally go to the invoice finance provider and they will take the loan amount and their fee from it before transferring the remaining funds to you. In some cases, you may receive the payment and then need to pay the provider.
The invoice finance provider will take a fee which is generally made up of two parts, one part is a service charge or administration charge to access the finance facility which is normally charged monthly. The second fee is normally a percentage fee applied to each invoice that funding is released from.
What types of invoice finance are available?
There are several types of invoice finance:
- Invoice factoring – this includes credit control services.
- Invoice discounting – this allows you to retain control of your credit control and customer accounts.
- Selective invoice factoring/discounting/finance – this is a service that allows you to select the invoices that you want to use for funding rather than using your whole sales ledger which is what traditionally what invoice finance products offer.
How does invoice factoring and invoice discounting differ?
There are some very distinct differences between invoice factoring and invoice discounting which include:
Invoice factoring features:
- Outsourcing of your credit control services
- Releases time and effort from your business in chasing invoices and tracking payments
- More often this is a disclosed service that your customers may be aware of
- They will assist you in running credit checks on your customers
- This is a less risky option for the lender as they have control of collection processes
- You may be required to take out bad debt insurance
Invoice discounting features:
- Generally, this is a confidential service
- Retain in-house credit control
- Maintain your customer relationships
- Tends to be available to those with a larger turnover and established credit control processes
- Tends to be cheaper than invoice factoring
Which is the best solution for my business?
It will depend on your business’ circumstances and preferences on whether invoice factoring or invoice discounting are best for you. As a rule of thumb generally, invoice factoring is most suited to smaller or less established businesses that don’t have credit control processes in place as they will benefit the most from outsourcing this facility.
Those that have robust financial processes and credit control tend to favour invoice discounting as it can provide a more confidential service and allows them greater control of their customer accounts and relationships.
Invoice discounting also tends to be a cheaper option but it can be restricted to businesses with larger turnovers so this may dictate which facility is available to you.